Recently, there has been a discussion in the forums where a poster in Arizona has sought suggestions from the community members regarding deficiency from foreclosure and taxes to be paid on it. Given below is the situation described by him in the forum:
The value of the poster’s current home in Arizona is low and if he sells it, there will be a deficiency of around $50k on the first mortgage. The poster says the home cannot be rented due to the present market condition. He wants to buy a new home in New Jersey and let this home be foreclosed. He has a credit score of 700+ and makes enough to afford one mortgage. He asks:
1. Can the lender sue him for deficiency in Arizona?
2. Can the lender come after his home in NJ for the deficiency in AZ?
3. Will he owe taxes on the deficiency?
Deficiency judgment in Arizona
If the poster cannot rent or short sell the AZ home in this market and lets it go into foreclosure, he will be responsible for the deficiency. Lenders in Arizona do have the right to pursue deficiency judgment against borrowers, provided the property is not less than 2.5 acres and it is not used as either a single 1-family or single 2-family primary residence. However, lenders will have to get the deficiency judgment within 90 days after the trustee’s sale.
In case, the poster purchases a property in New Jersey after the foreclosure in Arizona, the lender can come after his new home for the deficiency. The deficiency judgment can allow the lender to put a lien on his other properties. If the lender puts a lien on his new home, he can force a sale of the home to satisfy the lien.
Exemption from taxes on canceled debt
It is completely up to the lender if he will obtain a deficiency judgment or will forgive the deficient amount. In case he forgives the deficiency, the poster will be liable to pay taxes on it. The canceled debt is considered as a taxable income by the IRS. But there is a Mortgage Forgiveness Debt Relief Act 2007, which allows a borrower to exclude income from up to $2 million of canceled debts on the taxes ($1 million, if he is married, but files taxes separately). The act is applicable to debts discharged in the years 2007 through 2012. Since the poster has been using his home in Arizona as his principal residence, he should be able to claim exemption from paying taxes on the forgiven debt amount.
Buying new home after foreclosure
If the poster lets the home in Arizona be foreclosed and then wants to buy home in New Jersey, he will not be able to qualify for a mortgage. His credit will be negatively hit by the foreclosure and he will have to wait for at least 2 years to qualify for an FHA loan and 3-4 years for a conventional loan. In case he first purchases the home in NJ and then, lets the AZ home be foreclosed, he can qualify for the new loan in terms of credit scores. But his current mortgage will be taken into account for calculation of his debt to income (DTI) ratio. Unless he can show enough income to afford both mortgages, he cannot qualify for the new loan.
To view the discussion, you can refer to the page mentioned below:
http://www.mortgagefit.com/foreclosure/deficiency-taxes.html .