The lender sends a demand letter. As in asking for a note, this practice is not a current one. A lender may send a demand for payment of any deficiency following the sale of a home. Lenders use a demand letter if they don't want to give you an unsecured loan for the balance due. In essence, the problem is all yours, and you need to work out a way to pay the balance. Here again, if this scenario ever happens to you, get an attorney to advise you.

The lender forgives the debt. This is a current practice, but it can always change. The lender chooses to forgive the debt instead of pursue it. This practice is nice as far as it goes, but be prepared for the IRS to count the forgiven portion of the debt as income through the issue of a 1099 form. Forms 1099 A and C, which are normally used to document unreported income, are used to report forgiven debt. The amount of the forgiven debt becomes taxable income in most cases, unless you're covered by the Mortgage Forgiveness Debt Relief Act. If you're among the IRS's unforgiven and you get a 1099, and it is for a lot of money, we suggest that you see an attorney ASAP for legal options. Remember, the mortgage debt forgiveness law is federal and may not forgive state tax obligations.

The state you live in makes mortgages nonrecourse. If you live in certain states, you may get a break relating to personal mortgage deficiencies. Some states have passed laws saying that you are not responsible for any mortgage deficiencies. Some effectively make the mortgage a non- recourse loan. (Nonrecourse means the lender has no recourse to col- lecting money due other than the security on the loan.) You may not be personally liable. This protection may not apply to refinancing. See an attorney to find out whether it applies to you.

Subject to additions or deletions, the list of states that have passed some antideficiency protection legislation offering at least some pro- tection for borrowers includes Alaska, Arizona, California, Minnesota, Montana, North Dakota, Oregon, Texas, and Washington. The IRS wants more taxes. Even though a loan may be uncollectable or forgiven, it is not beyond the reach of the IRS. You see, the lender gets to take a loss on its taxes for the bad loan. Not wanting to miss a tax opportunity, the IRS considers the lender's loss to be your gain. So you may owe taxes on the deficiency amount if you don't qualify for relief under the Mortgage Forgiveness Debt Relief Act. This law is scheduled to run only until 2010. This amount can be a very big number indeed.

A foreclosed borrower faced with a sizeable 1099 still has hope. If you file IRS Form 982, "Reduction of Tax Attributes Due to Discharge of Indebtedness," and you are insolvent at the time of the forgiven debt, the IRS may forgive the liability. Again, see your attorney for the details.

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