Non-recourse debt or a non-recourse loan is a secured loan that is secured by a pledge
of collateral, typically real property, but for which the borrower is not personally liable.
If the borrower defaults, the lender/issuer can seize the collateral, but the lender's
recovery is limited to the collateral. Thus, non-recourse debt is typically limited to
50% or 60% loan-to-value ratios, so that the property itself provides "overcollateralization"
of the loan. The incentives for the parties are at an intermediate
position between those of a full recourse secured loan and a totally unsecured loan.
While the borrower is in first loss position, the lender also assumes significant risk,
so the lender must underwrite the loan with much more care than in a full recourse loan.
This typically requires that the lender have significant domain expertise and financial
modeling expertise. Nonrecourse debt is used for residential mortgage
loans in the United States, although most of Europe enforces mortgage debt forgiveness
after eviction.
Common uses Non-recourse debt is typically used to finance
commercial real estate, shipping or other similar projects with high capital expenditures,
long loan periods, and uncertain revenue streams. It is also commonly used for stock loans and
other securities-collateralized lending structures. Since most commercial real estate is owned
in a partnership structure, non-recourse borrowing gives the real estate owner the tax benefits
of a tax-pass-through partnership structure, and simultaneously limits personal liability
to the value of the investment. In some states, "antideficiency statutes"
provide that mortgages secured by personal residences are non-recourse against the borrower.
A non-recourse debt of $30 billion was issued to JPMorgan Chase by the Federal Reserve in
order to purchase Bear Stearns on March 16, 2008. The non-recourse loan was issued with
Bear Stearns's less liquid assets as collateral, meaning that the Federal Reserve will absorb
the loss should the value of those assets be below their collateralized value.
Self-directed IRA investors who choose to purchase investment real estate are able to
leverage their purchase with a non-recourse loan. Because of the IRS regulations, it would
be deemed a violation of the qualified retirement account status to personally guarantee any
loan on real estate owned by a self-directed IRA.
Non-recourse consumer legal funding Consumer legal funding is non-recourse financial
product that can be used to provide financial assistance to plaintiffs involved in a contingency
based lawsuit, such as a car accident. The funds are provided to the consumer on the
potential settlement amount. This money is true non-recourse funding, in that if the
case is lost, you owe the consumer legal funding company nothing. This is a purchase of an
asset and not a loan. Characterization
Non-recourse debt is usually carried on a debtor company's balance sheet as a liability,
and the collateral is carried as an asset. Tax consequences of disposition of property
encumbered by non-recourse debt For U.S. Federal income tax purposes, the
interaction among the concepts of the "amount realized" upon a disposition, the amount of
non-recourse debt, and the amount of adjusted basis in the property is fairly complex. The
tax consequences of a disposition depend on whether the taxpayer acquired the property
with the non-recourse debt already attached, or whether the taxpayer took out the non-recourse
debt after acquisition of the property, and the relative relationships between fair market
value and purchase price and disposition price. Basic concept: Computing gain or loss on a
disposition Upon a sale or other disposition of property
under U.S. income tax law, a taxable gain generally results where the amount realized
upon the sale or other disposition of property exceeds the amount of the taxpayer's adjusted
basis in that property. Generally, the amount realized is the amount
of cash and other consideration received by the taxpayer. The amount of any loan forgiven
or discharged is generally part of that consideration. The adjusted basis is the sum of the following:
the amount of the original cost incurred by the taxpayer when the property was acquired,
including the amount of any non-recourse debt assumed by the owner/taxpayer as part of the
acquisition, plus the costs of improvements made by the
taxpayer to the property, less the amount of depreciation deductions
allowed to the taxpayer on that property. If the amount realized exceeds the amount
of adjusted basis, the taxpayer has realized a gain at the time of disposition. If the
adjusted basis exceeds the amount realized, a loss has been incurred. The federal income
tax effect of non-recourse debt may be explained by first considering the tax effect of a disposition
involving recourse debt, and then contrasting against similar facts involving non-recourse
debt, as follows: Disposition of property subject to a recourse
debt Example:
The unpaid principal of the recourse debt is $100,000;
The fair market value of the property is $80,000; The taxpayer's adjusted basis in the property
is $45,000. Assuming that the creditor forecloses on the
property and that the $20,000 excess of the debt over the property's fair market value
is contractually discharged, the taxpayer would realize the $20,000 amount as income
from the discharge of indebtedness. That $20,000 of forgiveness would be taxable to the taxpayer
as ordinary income even though the taxpayer received no cash at the time of the discharge.
The $35,000 excess of the fair market value over the adjusted basis would be treated as
a taxable capital gain on the "sale or other disposition" of the property – again, even
though the taxpayer received no cash at the time of the foreclosure.
Disposition of property subject to a non-recourse debt
Assuming the same facts except that the debt is non-recourse, the result would be quite
different. The taxpayer would realize zero taxable ordinary income from the discharge
of debt. Instead, the entire $55,000 difference between the unpaid principal of the debt and
the taxpayer's adjusted basis would be treated as a taxable capital gain on the "sale or
other disposition" of the property—again, even though no cash is received by the taxpayer
at the time of foreclosure. At the sale, foreclosure or other disposition,
non-recourse debt incurred as part of the financing of the acquisition, and money extracted
from an investment by mortgaging out, are treated the same: both are taxable realization
only at the time of the property's disposition, even if, at time of disposition, the property
is worth less than the amount of the mortgage. Non-recourse debt that is in place at the
time of acquisition of the property is included in basis, Crane v. Commissioner, subsequent
borrowing is not. Woodsam Associates, Inc. v. Commissioner. Subsequent borrowing proceeds
reinvested in a depreciable property thereby avoid Woodsam and take advantage of Crane.
United States According to the National Consumer Law Center,
at least 10 states can be generally classified as non-recourse for residential mortgages:
Alaska Arizona
California Hawaii
Minnesota Montana
North Dakota Oklahoma
Oregon Washington
Recent legislation also makes Nevada non-recourse in most cases for residential purchasers for
mortgages obtained on or after October 1, 2009.
See also Finance
Mortgage loan project finance
Real estate Real estate appraisal
Recourse debt Synthetic lease
Footnotes ^ "U.S. new and existing home sales move in
opposite directions in April". Reed Construction Data. May 24, 2011. Retrieved 15 November
2013. ^ Congressional Budget Office. Fannie Mae,
Freddie Mac, and the Federal Role in the Secondary Mortgage Market. p. 49.
^ United Nations. Forest Products Annual Market Review 2008-2009. United Nations Publications.
p. 42. ISBN 978-92-1-117007-8. ^ Hogan, Cawlainn. "Spanish property bubble
fallout continues with evictions, debt and fear of homelessness". The Irish Times. "Unlike
most European countries, Spanish law does not enforce mortgage debt forgiveness after
eviction." ^ Ghent, Andra C. and Kudlyak, Marianna, Recourse
and Residential Mortgage Default: Theory and Evidence from U.S. States. Federal Reserve
Bank of Richmond Working Paper No. 09-10. Available at SSRN: http:ssrn.com/abstract=1432437.
The authors classify eleven states as non-recourse. The authors also discuss the reasoning for
this classification on a state-by-state basis. In several of the non-recourse states some
form of recourse is available but impractical due to lengthy and expensive judicial proceedings,
jury trials, and extended redemption periods. ^ Determination of amount and recognition
of gain or loss. Taxalmanac.com. ^ [1] . Justia. Justia.com
^ Unless the $20,000 qualifies as being excludable under 26 U.S.C. § 108.
^ Commissioner v. Tufts, 461 U.S. 300; Crane v. Commissioner of Internal Revenue, 331 U.S.
1. ^ Estate of Levine v. Commissioner, 72 T.C.
780, 792, aff’d, 634 F.2d 12; Woodsam Associates, Inc. v. Commissioner, 16 T.C. 649, aff’d,
198 F.2d 357. ^ Crane v. Commissioner of Internal Revenue,
331 U.S. 1. ^ Woodsam Associates, Inc. v. Commissioner,
16 T.C. 649, aff’d, 198 F.2d 357. ^ a b "COMPARISON OF STATE LAWS ON MORTGAGE
DEFICIENCIES AND REDEMPTION PERIODS". Connecticut Office of Legislative Research. 29 July 2010.
Retrieved 24 August 2013.