The Difference Between the Mortgage Forgiveness Debt Relief Act of 2007 and State Anti-Deficiency Laws

Services for Real Estate Pros with The Law Offices of Elisabeth A. Lambert

A week or so ago, I wrote a post detailing the Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA) because I'd read a number of posts where the authors confused the MFDRA with their state's anti-deficiency laws. That post was lost when AR timed out on me when I went to publish the post.

If you want to get the information from the horse's mouth (the IRS) here's a link to the IRS publication regarding the MFDRA. I'm summarizing it below.

The main difference between MFDRA is who is providing the protection. MFDRA is federal law and applies to your federal income taxes. Anti-deficiency laws vary state by state and protect the borrower from the lender holding them liable for the deficiency (the difference between the amount owed and the actual sale price) in a short sale or foreclosure.

What is the MFDRA 2007

As a response to the mortgage and credit crisis, Congress passed this Act in late December of 2007  It generally, permits a taxpayer to exclude the forgiveness of cancellation of certain debt from counting as ordinary income on their federal taxes if the property at issue is the taxpayer's principal residence. Cancellation or forgiveness of debt usually occurs when the lender modifies the terms of a mortgage, accepts a short sale or forecloses on a property. MFDRA will apply to forgiveness and cancellation of debt occurring in 2007, 2008 or 2009.


Prior to December 2007 Mortgage Debt Relief Was Handled Differently

Prior to the enactment of the MFDRA, when a lender offered to modify the terms of the loan by either forgiving or canceling debt, the taxpayer would have to include the debt relief amount as ordinary income.

For example, if there was $300,000 owed on the taxpayer's principal residence and the property only sold for $250,000, prior to MFDRA, the taxpayer would have to show the debt relief of $50,000 as income on his/her taxes.

With the MFDRA, the taxpayer does not have to include that $50,000 debt relief as income.

Debts to Which the MFDRA Applies

Not all forgiven or canceled debt qualify for MFDRA treatment.  It only applies to forgiven or canceled debt that was used to buy, build or substantially improve the taxpayer's taxpayer's principal residence.


Debt used to refinance a taxpayer's home will qualify up to the extent that the principal balance of the old mortgage, immediately prior to refinancing would have qualified.

What About Debt Forgiveness on a second home, credit cards or car loans?

This property DOES NOT QUALIFY for MFDRA treatment. Only canceled debt used to buy, build or improve the taxpayer's principal residence or refinance debt incurred for those purposes qualifies for this exclusion.

Check With Your Tax Advisor Because If Part of the Forgiven Debt Doesn't Qualify for Exclusion from Income, It May Qualify Under A Different Provision

The forgiven debt may qualify under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. There are additional exclusions that may be explored with your tax advisor.

 What are Anti-Deficiency Laws

Anti-deficiency laws differ by state and usually protect the borrower from being liable for the difference in the sale price of the principal residence and the amount owed on the principal residence. If a borrower is protected by anti-deficiency laws, it protects them from the lender holding the borrower liable for the deficiency. Many restrict this protection to purchase money loans only, so if the property is refinanced then the borrower may lose the protection of the anti-deficiency laws. I will cover this in more detail in a future post.


Please remember me and Asset Preservation, Inc. for all of your 1031 exchanges and questions.

 Lisa A. Lambert, Esq. 877.646.1031 or

Asset Preservation, Inc. 800.282.1031 or or








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Randy "Lazarus" McAtee
Lazarus Realty - Fresno, CA
Owner/Broker, Lazarus Realty, Fresno California



great artilcle.

could you clarify this

"Debt used to refinance a taxpayer's home will qualify up to the extent that the principal balance of the old mortgage, immediately prior to refinancing would have qualified."


some people have re-fied numverous times. 

assume home purchased for 100k

later refinanced for 170k

then refied again for 250k

then again for 325k

home is foreclosed upon and sells for 180k

Will owner have any tax liability or is above covered under MFDRA?



Jun 26, 2008 10:42 AM #1
Lisa Lambert
The Law Offices of Elisabeth A. Lambert - Fresno, CA
Esq. 1031 Exchange Expert


My understanding is the MFDRA would cover the principal balance just prior to refinancing the first time. Assuming that it was 100% financed, the MFDRA would cover the balance of the $100,000 loan just prior to the first refinance. So, also assume that the balance at that time was very close to $100,000.

At the time of sale, the lender may be forgiving(you need to check the language of the documents because they probably are not waiving their rights to recover the deficiency on the last refi)  the $145,000.  Under MFDRA, my understanding is that $100,000 would qualify and not be considereed income for federal tax purposes but the $45,000 would be considered income unless they used those re-fis to "substantially improve"  the property, then the whole amount would be covered by MFDRA.

Now, regarding anti-deficiency laws. My understanding is that the antideficiency laws in the state of California only apply to "purchase money" loans. Once they refi'ed they lost the protection of the anti-deficiency statute.

Your client needs to talk to their tax advisor to sort out their potential tax liability and whether the lender may come after them for the $145,000 deficiency.

This is a complicated area and my purpose in providing the information was to point out the differences between the federal income tax relief and anti-deficiency laws because as you can they are easily confused.

I would highly recommend not getting into specifics with your clients but point out the need to meet with their tax advisor regarding the tax implications and potentially an attorney regarding the deficiency issues. You don't want them thinking that you are giving them advice on these issues because of the liability exposure you may assume.




Jun 26, 2008 10:59 AM #2
Mirela Monte
Buyers' Choice Realty - North Myrtle Beach, SC
Myrtle Beach Real Estate

Lisa, please insert this to our Optimist group also and I will make it a featured post.  It is extremely informative and I want to share it with the group and keep it engaged by our comments.

You've done an exceptional job on this!  Thank you!

May I have your permission to post it on my company's blog?

Jun 26, 2008 01:56 PM #3
Lisa Lambert
The Law Offices of Elisabeth A. Lambert - Fresno, CA
Esq. 1031 Exchange Expert


I will re-post it to The Optimist Group. You may absolutely post it on your company's blog.


Jun 26, 2008 02:18 PM #4
R. B. "Bob" Mitchell - Loan Officer Raleigh/Durham
Bank of England (NMLS#418481) - Raleigh, NC
Bob Mitchell (NMLS#1046286)

Excellent post!  I'm glad that you pointed out the differences between the two and the limitations on the IRS plan.  Personally, I've always thought that taxing people on a gain that they don't realize after they've lost their home was a bit harsh!


Bob Mitchell

ValueList Real Estate Services, Inc.

Jun 27, 2008 04:41 AM #5
Lisa Lambert
The Law Offices of Elisabeth A. Lambert - Fresno, CA
Esq. 1031 Exchange Expert


Prior to the MDFRA the IRS was not taxing people on gain, rather they were being taxed on the debt amount that the lender forgave. Their point of view was that the "debt relief" was equivalent to ordinary income. MDFRA permits the taxpayer to exclude that debt relief from being counted as ordinary income if the loan was a purchase money loan for a principle residence (refis are discussed above).

Remember, that gain is the difference between Net Adjusted Basis (the amount the property was purchase with some adjustments for improvements and depreciation) and the amount the sale price of the property.

Typically, if the property sells for less than it was purchased there will not be any gain (unless the property was purchased in a 1031 exchange which would lower the basis by the amount of gain deferred in the exchange).

Just thought I'd clarify that point. There's a big difference between being taxed on a capital gain and being taxed on debt that was forgiven.


Jun 27, 2008 08:08 AM #6
Jane Lee

Hi Lisa,

Thank you for this great article. I live in Arizona and me and my boyfriend are seriously considering foreclosing on our primary residence. It's not that we cannot afford the payment, but it's because we feel that we don't have the incentive to continue making our payments due to declining home values. We owe $300,000 our house is worth about $200,000. We have $50,000 in the bank & a rental property with no equity, but we simply don't want to continue paying because it defeats the purpose of owning a primary home & hoping in 3-5 years we can sell it for more. Knowing that we have assets, if we foreclosed are we protected by the Anti-deficiency law and the Forgiveness Debt Relief Act?

I would appreciate any answers or suggestions. I've lost 20lbs and have not been sleeping and eating for the last months thinking about this. Any info will help. Thank you


Jane Lee

Jul 21, 2008 09:30 PM #7
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