What Is Recourse?

A recourse is a legal agreement that gives the lender the right to pledged collateral if the borrower is unable to satisfy the debt obligation. Recourse refers to the lender's legal right to collect. Recourse lending provides protection to lenders, as they are assured of having some repayment, either in cash or liquid assets. Companies that use recourse debt have a lower 澳洲幸运5官方开奖结果体彩网:cost of capital, as there🦩♐ is less underlying risk in lending to that firm.

Understanding Recourse

Recourse provides the legal means for a lender to seize a borrower's assets if the borrower defaults on a debt. If the debt is full r⭕ecour🔥se, the borrower is liable for the full amount of the debt even to the extent it exceeds the value of the collateralized asset.

Recourse debt allows the lender to take other assets from the borrower besides the collateral in order to repay the debt. In most cases, the lender may obtain a 澳洲幸运5官方开奖结果体彩网:deficiency judgment to seize unpledged assets, levy bank accounts, or 澳洲幸运5官方开奖结果体彩网:garnish wages. The lende💧r may also go after other sources of income from the borrower, sucܫh as commissions, royalties, or investment income.

Recourse vs. Non-Recourse

Recourse loans are distinct from 澳洲幸运5官方开奖结果体彩网:non-recourse loans, which limit the lender to claiming only the specific asset pledged as colꦉlateral. If a borrower defaults on a non-recourse loan and the value of the collateral does not cover the amount the borrower owes, the lender cannot attempt to recover the balance by seizing the borrower's other assets.

The lender only has a legal right to the pledged collateral. Because of this distinction🌟, recourse debt favors the lender, while non-recourse debt favors the borrower.

Recourse debt is th꧂e more common form of debt because it is less risky for lenders. Non-recourse debt is usually limited to longer-term loans placed on stabilized and performing assets, such as commercial real estate.

Tax Impact of Recourse on Borrowers

Recourse debt has two tax implications for borrowers that translate into recognizing taxable ordinary income and reporting a loss or gain. When filing their taxes, the borrower must report as ordinary income any part🥀 of a debt๊ that is forgiven by the lender.

For example, if a lender 澳洲幸运5官方开奖结果体彩网:forecloses on a house to recover a $150,0🌠00 debt and sells it for $125,000, the borrower still owes $25,000. If the lender forgives the $25,000, the borrower must repﷺort this amount as ordinary income for tax purposes.

If the debt is non-recourse🔜, the forgiveness of the loan does not result in taxable cancellation of debt income, since the terms of the loan do not give the lender any rights to pursue the owner personally in case of default.

Regardless of whether a debt is forgiven, the borrower must report a loss or gain based on the difference between the original loan amount and the amount realized in the sale of the asset. In the above example, the $25,000 must be reported as a loss. Losses incurred through the sale of deficient assets are not 澳洲幸运5官方开奖结果体彩网:tax-deductible.

Special Considerations

Most loans are issued with recourse language included in the loan document. The langua🎉ge specifies the recourse actions the lender may take along 🐭with any limitations.

Generally, whether a loan is a recourse or non-recourse depends on the state where the loan originated. Most states provide for recourse for mortgage lenders, but it may be restricted in some way. For example, in some states, the deficiency judgment the lender can obtain against the borrower cannot exceed the 澳洲幸运5官方开奖结果体彩网:fair market value (FMV) of the property.

For example, consider a home that has a mortgage balance of $250,000 and a fair market value of $200,000. If the lender sells the home at auction for $150,000, it can only recover a $50,000 deficiency judgment against the borrower, which is the difference between the FMV and the amount the home sold for at auction. In some states, lenders are prohibite﷽d from obtaining deficiency judgments.

Example of Recourse

Company ABC 🐲is a delivery company that needs to replace its fleet of outdated trucks. It needs to buy five new trucks that cost a total of $250,000. Company ABC only has $50,000 in cash to spend on the trucks so it borrows $200,000 from Bank XYZ. The loan is a recourse loan and the pledged collateral is the trucks.

After three years, Company ABC's business has been performing poorly and it can no longer make payments on its loan to Bank XYZ. It still owes $125,000 on its loan. As per the terms of the recourse loan, Bank XYZ ceases the trucks that were pledged as collateral; however, due to the depreciation of the trucks, they arꦓe only worth $75,000, mea💝ning there is a shortfall of $50,000 in covering the outstanding amount on the loan.

Because the value of the collateral does not cover the outstanding amount on the loan,൲ and because the loan is a recourse loan, Bank XYZ seeks to obtain other assets of Company ABC to cover the difference. The two companies come to an agreement whereby Company ABC will hand over certain operating equipment with a total valu🐭e of $50,000 to make whole on the loan.

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