Pitfalls in Escaping Distressed Real Estate in Arizona

Posted over 2 years ago. Applies to Arizona, 1 helpful vote

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Since the real estate market began to decline in 2006, followed by its dramatic crash in 2007, I have counseled many hundreds of individuals needing to escape distressed or underwater properties. There are several common elements in the concerns of those homeowners. Some have wanted to attempt a short sale, others preferring to simply allow foreclosure to occur. Over the past few years I have become increasingly convinced that most owners’ concerns are based on three crucial questions which must be answered when determining whether or not it’s possible, or even advisable, to attempt to dispose of a distressed property.

What is my legal liability?

In other words, if a homeowner conducts a short sale or allows the foreclosure of his property, can the lender sue him for any unpaid balance due on the loan? Arizona is among the best places in the United States when it comes to legal liability (with respect to home loans). In many cases homeowners are relieved to learn that they are protected by one of Arizona’s consumer protection statutes. Arizona’s anti-deficiency statutes apply, in most cases, to investment properties and to so-called “ strategic defaults." However, knowing how to apply Arizona law to a specific homeowner’s situation may require the skill and expertise of a professional.

What is the impact of a strategic default or short sale on my credit score?

It is impossible prior to a short sale or foreclosure to determine exactly the amount of credit damage to a borrower’s FICO score. Credit rating impact varies greatly depending on the borrower’s score at the outset of the process, the number of missed payments, and on whether the homeowner chooses to short sale the home or to abandon the home through a foreclosure. The past several years have illustrated that selling the distressed property in a short sale is virtually always significantly better for a borrower’s credit than simply abandoning the property. This is one of the reasons why a short sale may the best means of escaping a distressed property for many individuals.

What are the tax consequences?

Many of my clients are surprised to learn that when debts they owed to a bank or individual are canceled, they may owe income taxes. This issue comes up frequently in connection with escaping distressed real estate. It is customary following a foreclosure or short sale for the bank to issue a 1099 to the borrower and the IRS indicating the amount of debt canceled. In many cases the amount of debt cancelled can result in significant tax liability. However, there are several exceptions that usually allow homeowners to avoid payment of debt cancellation taxes. Most notably, The Mortgage Debt Relief Act of 2007. This act applies to all 50 states and basically provides no tax on the short sale difference or foreclosure deficiency of a purchased money loan, or a loan used to improve the home, if it’s a primary residence. This law is currently scheduled to sunset at the end of tax year 2012.

In seeking and receiving answers to these, and other questions, there is no substitute for obtaining advice from a knowledgeable attorney. It is becoming increasingly clear that Arizona property owners who fail to seek out skilled legal counsel prior to disposing of distressed real estate do so at their peril.

Additional Resources

Things to Consider Before Attempting to Escape Distressed Real Estate in Arizona

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