A big question that arises in California these days is whether the debt on your real estate is recourse or non-recourse. The difference can be quite significant if you are going through a foreclosure, deed in lieu of foreclosure, or a short sale. If the debt is non-recourse and you go through a foreclosure, deed in lieu of foreclosure, or a short sale, there is no potential for a deficiency on the loan and there is no income from any cancellation of debt. However, if the debt is recourse there is a potential for a deficiency and income from cancellation of debt. Recourse debt creates personal liability for the debtor for the portion of the debt that is not repaid to the lender. That is why this determination of recourse v. non-recourse is so important as an initial hurdle.
A note can be non-recourse if the contract that creates the debt indicates that it is a non-recourse note. Purchase money notes in California are also non-recourse by definition. A purchase money note is a note whereby the borrower borrowed money to purchase a principal residence and the funds went directly into escrow and then to the seller of the property for the purchase of a one to four unit property. Thus, seconds, HELOCS and Refinanced Loans on property would typically not be a purchase money note and would create personal liability in the event of a default on the note.
California has come to the rescue with SB 931 with regard to short sales. If a lender agrees to a short sale in writing in California the First Trust Deed on a one to four unit property is non-recourse and the lender can only look to the property for repayment. Notice that this Bill does not exclude rental properties. Therefore, if a borrower has a potential issue with a deficiency on a first trust deed, whether it is a rental or a principal residence, the borrower should attempt to short sale the property to avoid a deficiency judgment of the property. SB 931 does not work for foreclosures or deeds in lieu of foreclosure. It is only for short sales.
When you are disposing of distressed real estate there are numerous tax and legal issues that you must address and be aware of prior to closing the transaction. Make sure that you consult with a tax attorney to make sure you do not have any hidden costs that you will be later surprised by when it is too late.