The home (investment/rental) was foreclosed on in June 2012. The mortgage company took possession as a buy back. The amount of debt "discharged" is $53,415.39 and the 1099 box 5 checked, states that I'm "personally responsible for the repayment" of the debt. #1.. Am I responsible for the repayment, as AZ is a Non-Recourse state, and #2 what is my tax obligation? How can it be a "discharged" debt and be "paid back"? Isn't it either or? My tax man is a bit confused as well. If I'm expected to repay the amount, how would that be taxable?
For investment properties that are foreclosed, two tax issues arise, forgiveness of debt income (if the house was underwater) and capital gains.
I have no comment on whether it is true that AZ is a non-recourse state in "all" foreclosure scenarios, but let's assume so for the sake of argument. If the debt is really non-recourse, then no cancellation of debt occurred to give rise to forgiven debt income.
However, since the property was an investment property, you need to address the capital gains issue. So, you will need to work on Schedule D and possibly IRS Form 8949. The amount of discharged debt may reduce your basis (creating an adjusted basis) and resulting in a taxable gain. I know, it sucks.
For example, owner buys investment property for $200,000. Owns it for 5 years and depreciates it for 5 years at $10,000 per year (trying to keep math simply). The home is foreclosed resulting in $50,000 of non-recourse discharge debt. This results in an adjusted basis of $100,000. The house, at foreclosure auction sells for $130.000. Result: you have a reportable and taxable gain of $30,000.
You probably need to seek out a new account more familiar with real estate tax issues. The above example is a very simplistic example, and I am not saying that the entire amount of the non-recourse deficiency necessarily reduces your basis, a calculation and worksheet needs to be done.
Arizona is an anti-deficiency state so long as the property that was foreclosed was 2 1/2 acres or less, plus used and occupied as a one or two family dwelling. Not necessarily the owner's dwelling, but any human. As to the tax issues - you need to talk to a good tax attorney or CPA. The fact that your "tax man is a bit confused" leads me to think you may need a new tax expert who is experienced with these type of issues.
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Instead of a "tax man" you need to go to a CPA. The resolution depends in part on whether you have personal liability or not, and I cannot tell based on what you have described; it is a question of state law and the fine lawyer who answered you, who is from Arizona, has described how you might not have personal liability. It is also a question of your basis in property, which the other fine lawyer who responded to you described. So this is a fact-intensive situation, the answer to which you cannot get from an internet site. You must go and sit donw, face-to-face, with a competent CPA in Arizona.
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