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Richard, Tax Attorney
Category: Tax
Satisfied Customers: 55132
Experience:  29 years of experience as a tax, real estate, and business attorney.
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Thank you. I had a home in Arizona that was foreclosed on

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Thank you. I had a home in Arizona that was foreclosed on in 2012. Arizona has "forgiveness Law", which means the borrower will not be taxed on the amount that the Lender lost on the loan. I filed my taxes in WA state and this tax preparer charged me taxes on this amount for my Federal return, stating that the law only refers to State taxes. Is she correct?
Welcome! My goal is to do my very best to understand your situation and to provide a full and complete answer for you.

Good evening. Could you tell me whether this was your principal residence? Thanks.
Customer: replied 4 years ago.

not a black / white issue. Reason: I lived in another "primary" residence when I bought it, so I put 20% down (I was going thru a divorce); once we sold our marital primary home, I did move into this (subject) property and lived there until I moved to Seattle. So, technically, it was a secondary residence, and I did rent it out when I moved to Seattle, for awhile, then it sat vacant for 2 years. Hope that answers your question.

Thanks. BotXXXXX XXXXXne is you are not going to owe tax on the amount of the deficiency. You have two possibilities to avoid tax liability. One would be if this were your principal residence. Normally, debt forgiveness results in taxable income. But under the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was $2 million or less. The limit is $1 million for a married person filing a separate return. Under the Act, PRINCIPAL RESIDENCE- For purposes of this subsection, the term `principal residence' has the same meaning as when used in section 121.'. Section 121 of the IRS code deals with capital gains tax exclusion on principal residence if a person lives in the home for the past 2 (aggregated) of 5 years. So, if you meet the definition of "principal residence" then you could exclude any forgiveness under this Act. And, this is a FEDERAL law, and it is specifically applicable to your FEDERAL tax return.

If you don't meet the definition of principal residence, then you are not going to have to include any deficiency because of the Arizona non-deficiency statute. If you meet the requirements of the Arizona statute, then it's a non-recourse loan for which you never had any liability for any deficiency. If you have no liability, there can by definition be no forgiveness because you can't be forgiven for something you never owed in the first place. Thus, no recourse for the deficiency means no forgiveness of debt which in turn means no inclusion of forgiveness for your taxes. This is not limited to your state return. If the loan is a non-recourse loan, there is no liability, so there is no forgiveness on either the state or federal level.

Thank you so much for allowing me to help you with your questions. I have done my best to provide information which will be helpful to you. If I have not fully addressed your questions or if you have any follow up questions, or if I have misinterpreted your questions in any way, please do not rate me yet, but simply ask a follow up question without rating so I can provide you with a fully satisfactory answer. If I have fully answered your question(s) to your satisfaction, I would appreciate you rating my service with 3, 4, or 5 faces/stars so I can receive credit for helping you today. I thank you in advance for taking the time to provide me a positive rating!
Customer: replied 4 years ago.

I'm sorry, but I am a tiny bit confused. So , it was not my principal residence, because I did not live in it for 2 years. So the last part of your paragraph applies to me, but I don't quite understand what you are saying. Can you tell me if I need to go back to my tax preparer and tell them if they are wrong? They are saying that I am liable for taxes on the loss in regards XXXXX XXXXX Federal return.

Thanks for following up. Yes, go back to your preparer and tell him he is wrong. This loan was non-recourse due to falling with the Arizona non-deficiency statute. Since it was non-recourse, there was no forgiveness of debt because you never had any liability. Therefore, you owe no taxes on the shortfall amount since you never owed it in the first place.
Customer: replied 4 years ago.

Thanks very much. If I have any other questions regarding this subject, do I have to start over again and pay another fee? or can I come back to you?

You're's my pleasure. Just come back to me and I'll be happy to help you. :)
Customer: replied 4 years ago.

but in order to get back to you, I will have to pay another $43.00. Can I have your direct contact? or no?

Just come back to this same thread; you don't have to pay again. :)
Customer: replied 4 years ago.

okay, shall I rate you now? or wait until I get this cleared up completely?

I'd appreciate it if you would rate at this point; but it's entirely up to you. :)
Richard and 3 other Tax Specialists are ready to help you
Thank you so much! Just let me know if you have any further issues regarding this. I'll be happy to help for no additional charges. Have a great evening.
Customer: replied 4 years ago.

Thank you. I've been in one helluva pickle today. When I told the CPA who already prepared my taxes with the cancellation of debt on my return, to please correct it, she refused and told me to go elsewhere. I then had to find a tax preparer in the lovely (clueless) state of WA to prepare my taxes today. Most of them turned me down, because they didn't know anything about the AZ Statute. I found one girl who told me she would file them the way I asked, but wouldn't give their normal "guarantee". So, I had to go with that. It's been very strange, indeed. I know you are right, because you aren't the first attorney to tell me this. But up here in Seattle, they want to go by the books and not go the extra mile to research it or make a call. Anyway.... I'm hoping for the best. Thanks again.

Thanks for following up. It's always difficult when you're dealing with an accountant in one state and a property subject to another state's law. And, accountants are numbers people, not legal people. Have a great weekend!