Tufts and the Evolution of Debt-Discharge Theory

Abstract

Copyright 1992 Deborah A. Geier.

Consider poor Debtor, who purchased a personal residence for $130,000 several years ago with a hefty mortgage and today, like many others caught between the Scylla of the economic recession and the Charybdis of collapsing real estate values, finds himself losing his home. Perhaps he loses his home because he can no longer continue to meet the mortgage payments. Perhaps he simply stops making mortgage payments because he appreciates the economic reality that it would not be wise to continue to make payments on the $122,000 remaining mortgage when the fair market value of the home has plunged to $100,000. This approach would be particularly appealing if Debtor knew that the creditor would not, or could not, enforce any deficiency against Debtor's other assets.
What are the tax consequences upon transfer of the home to the mortgagee infull satisfaction of the debt? Upon researching the law, Debtor's tax advisor learns that, because the debt discharged ($122,000) exceeds the fair market value of the property transferred in satisfaction of the debt ($100,000), the tax consequences will vary dramatically depending on whether the debt is styled "recourse" or "nonrecourse."