It is common for homeowners to have a house that is "upside down", many with first and second mortgages. Houses that were purchased a number of years ago appreciated rapidly in a short period of time and it was easy to pull on the home's equity by securing an equity line of credit. That equity may have been used for many purposes, including home improvements, constructing a swimming pool, funding college educations, purchasing new cars or boats, paying off credit cards and investing in businesses. These loans are second loans behind the original purchase money loan and are commonly called Home Equity Lines of Credit or Home Equity Credit Lines ("HELOCs").

When homeowners are deciding if they can afford to keep their house by continuing to carry their first mortgage and their HELOC, they need to consider whether or not the HELOC will be covered under Arizona's anti-deficiency statutes and what the tax consequences are of a foreclosure or short sale.

In our recent article "I Received a 1099 from My Lender - Now What?" we discussed the tax consequences in Arizona of a foreclosure or a short sale when the loan is the original purchase money loan and there is no HELOC. This article will examine the tax consequences of a foreclosure when the personal residence has both its original purchase money loan and a HELOC. It is important to note, that a refinance of an original purchase money loan with or without a HELOC is not covered in this article.