What is the difference between Recourse and Non-Recourse Debt?
Most Taxpayer do not really understand the distinction between Recourse and Non-Recourse Debt and whether the debt forgiveness is taxable.
What is Recourse Debt?
1. Recourse debt is debt for which the taxpayer is personally liable. In the event of default, "the lender can look beyond the collateral pledged for the loan and hold the borrower accountable for the unpaid balance."
2. When a lender takes over a property as part of a foreclosure, deed in lieu or as part of a short sale in satisfaction of a recourse note "the deemed sale price will be the lesser of the FMV of the property at the time of foreclosure or the amount of secured debt."
3. If the taxpayers debt exceeds the FMV, the difference is treated as debt discharge income if it is forgiven.
What Non-Recourse Debt?
1. Nonrecourse debt is debt where the lender can only look to the loan collateral in the event the taxpayers default's on the loan.
2. In a foreclosure, deed in lieu, the sale proceeds from the deemed sale is equal to the balance of the non-recourse debt. Accordingly, there is no debt forgiveness when the note is a nonrecourse note.
The importance of understanding the distinction between a non recourse debt adn a recourse debt is that a foreclosure on property involving recourse debt could result in both a gain or loss from the sale of property, and debt discharge income.