Non-recourse debt is a loan secured by specific collateral where, if you default, the lender’s only remedy is to take that collateral. Your bank accounts, wages, home, and other property stay out of reach, even if the collateral sells for less than you owe. This structure shows up most often in commercial real estate, federally insured reverse mortgages, and loans made to self-directed retirement accounts, and it changes both your personal liability and the tax treatment of a foreclosure.
How the Lender’s Remedy Is Limited to the Collateral
In a non-recourse loan, the promissory note states that the lender will look solely to the pledged collateral for repayment. No other asset of the borrower can be levied, executed against, or otherwise used to satisfy the debt. The provision usually sits under a heading like “Non-Recourse Obligations” in the loan documents.
If you stop paying, the lender forecloses on the property and the debt is extinguished. Federal tax regulations confirm that disposing of property securing a non-recourse liability fully discharges the borrower from that liability.1eCFR. 26 CFR Part 1 – Determination of Amount of and Recognition of Gain or Loss Even if the sale leaves a shortfall, the lender cannot sue for the balance, and you owe nothing further on the loan itself.
Non-Recourse Debt vs. Recourse Debt
The practical difference between the two is what the lender can do after taking the collateral. With a recourse loan, the borrower is personally liable, and the lender can garnish wages or levy accounts to collect any remaining balance. With a non-recourse loan, the lender can only foreclose on the pledged property and cannot pursue any shortfall.2IRS.gov. Recourse vs. Nonrecourse Debt
Because the lender absorbs more risk, non-recourse loans typically carry higher interest rates, tighter collateral standards, and lower loan-to-value ratios. Federal Reserve research on commercial real estate lending found that recourse loans receive loan-to-value ratios roughly 2.8 percentage points higher than otherwise comparable non-recourse loans, because the lender’s access to the borrower’s personal assets reduces its risk.3Federal Reserve Board. Recourse as Shadow Equity – Evidence From Commercial Real Estate Loans
The tax consequences of a default also diverge sharply, which the tax section below works through.
Where You Actually Encounter Non-Recourse Debt
Most consumer loans are recourse. Non-recourse financing shows up in a handful of specific places.
- Commercial mortgage-backed securities (CMBS): Most CMBS loans are structured as non-recourse by design, with the lender’s recovery limited to the financed property. “Bad boy” carve-outs can still convert the loan to recourse under specific misconduct.3Federal Reserve Board. Recourse as Shadow Equity – Evidence From Commercial Real Estate Loans
- Reverse mortgages (HECM): The federally insured Home Equity Conversion Mortgage program is non-recourse by regulation. HUD rules state that the borrower has no personal liability for the outstanding balance, the lender may enforce the debt only through sale of the home, and no deficiency judgment is allowed if the home is foreclosed.4eCFR. 24 CFR Part 206 – Home Equity Conversion Mortgage Insurance
- Self-directed IRA real estate loans: When a self-directed IRA buys investment property with borrowed money, the loan must be non-recourse. A personal guarantee by the account holder would create a prohibited transaction. Lenders generally require 35% or more down and restrict the loan to non-owner-occupied investment property.
- Residential mortgages in anti-deficiency states: Roughly a dozen states have laws making certain residential purchase-money mortgages non-recourse by statute. In those states, after foreclosure the lender cannot pursue you for the difference between the sale price and the loan balance.
What It Takes to Qualify
Because the collateral is the lender’s only backstop, underwriting is stricter than on a comparable recourse loan.
Lower Loan-to-Value Ratios
Non-recourse lenders keep loan-to-value ratios conservative to build an equity cushion against value declines. On commercial loans, ratios commonly fall between 50% and 65%. Federal Reserve data on commercial real estate puts the overall average LTV at 57%, with non-recourse loans at the lower end of the range.3Federal Reserve Board. Recourse as Shadow Equity – Evidence From Commercial Real Estate Loans An appraisal has to confirm that the property’s market value comfortably exceeds the loan at origination.
Net Worth and Liquidity
You are not personally on the hook for repayment, but lenders still size up your finances. Fannie Mae’s multifamily lending guidelines, for example, require that the combined net worth of the borrower and all key principals equal or exceed the original loan amount, and that the borrower hold liquid assets equal to at least nine monthly principal-and-interest payments after closing. Retirement accounts like IRAs and 401(k)s do not count toward that liquidity test.5Fannie Mae. Small Mortgage Loans
Income-Producing Collateral
The property has to generate enough reliable cash flow to service the debt. Non-recourse lenders concentrate on income-producing real estate like apartment buildings, offices, and retail centers, and they require detailed financial projections before funding. A security agreement identifies the specific collateral, and the lender records a mortgage or deed of trust to secure a priority claim.
What Happens If You Default
If you miss payments, the lender forecloses on the collateral through either a judicial foreclosure or a trustee’s sale, depending on the state’s procedures. Public notices and a statutory waiting period precede the transfer of ownership.
Once the lender takes the property, the loan obligation is gone. Even if the sale leaves a large shortfall, no deficiency judgment is available and no other asset of yours is exposed.2IRS.gov. Recourse vs. Nonrecourse Debt What the foreclosure does not do is end your dealings with the IRS, and that is where many borrowers get surprised.
The Tax Treatment of a Non-Recourse Foreclosure
The IRS treats a non-recourse foreclosure as a sale of the property. That can produce a taxable gain even when the property has lost value, which is counterintuitive.
The Amount Realized Is the Full Loan Balance
Under Treasury regulations, when property securing a non-recourse liability is disposed of, the amount realized includes the full outstanding balance of that debt, not the property’s current fair market value.1eCFR. 26 CFR Part 1 – Determination of Amount of and Recognition of Gain or Loss The Supreme Court confirmed this rule in Commissioner v. Tufts, holding that the outstanding non-recourse obligation is included in the amount realized regardless of whether the debt exceeds the property’s market value.6Library of Congress. Commissioner of Internal Revenue v. Tufts et al., 461 U.S. 300
Put concretely: if you owe $1.8 million on a non-recourse loan against a building whose adjusted basis is $1.6 million, the foreclosure produces a $200,000 taxable gain, even if the property is worth far less than the loan at the time it changes hands. Years of depreciation deductions reduce basis and amplify this effect.
No Cancellation of Debt Income
The offsetting advantage is that a non-recourse foreclosure does not generate cancellation of debt (COD) income. The IRS states that if property subject to non-recourse debt that exceeds the property’s fair market value is foreclosed, the result is not ordinary income from cancellation of debt.7IRS.gov. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments The whole non-recourse balance is treated as part of the amount realized on the sale. COD income from recourse debt is taxed at ordinary rates up to 37%, while gain from a non-recourse foreclosure is taxed according to the character of the property, often at lower long-term capital gains rates.
Capital Gains Rates and Depreciation Recapture
If you held the property more than a year as a capital or business asset, long-term capital gains rates of 0%, 15%, or 20% generally apply, depending on your taxable income.8Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed For 2026, the 0% rate applies to single filers with taxable income up to $49,450 and joint filers up to $98,900. The 20% rate starts above $545,500 for single filers and $613,700 for joint filers.
If you took depreciation on the property, part of the gain is taxed separately. Under the unrecaptured Section 1250 gain rules, gain attributable to prior depreciation on real property is taxed at up to 25%.8Office of the Law Revision Counsel. 26 U.S. Code 1 – Tax Imposed On a property with heavy depreciation, this recapture can be the single largest piece of the final tax bill.
Forms You’ll Receive and File
The lender sends Form 1099-A (Acquisition or Abandonment of Secured Property) after a foreclosure, showing the outstanding balance and whether you were personally liable.9IRS.gov. Instructions for Forms 1099-A and 1099-C If the lender also cancels any remaining debt in the same year, you may get a single Form 1099-C covering both events.
Where you report the gain or loss depends on how the property was used. Business or trade property is reported on Form 4797. Investment property held as a capital asset goes on Schedule D and Form 8949.10IRS.gov. Publication 544 – Sales and Other Dispositions of Assets Getting the adjusted basis right — original cost, plus improvements, minus all depreciation — is what makes the final number correct.
When Non-Recourse Protection Disappears
Non-recourse protection is not absolute. Most non-recourse loan agreements contain “bad boy” carve-out clauses that convert the loan to full recourse if the borrower engages in specific prohibited conduct. Once triggered, the lender can go after personal assets just as it would under a conventional recourse loan.
Common triggers include:
- Fraud or misrepresentation in the loan application or financial reporting.
- Waste, meaning physical deterioration or failure to maintain the property; some agreements define this broadly enough to capture deferred maintenance.
- Allowing a property tax lien to attach that takes priority over the lender’s mortgage.
- Selling, conveying, or encumbering the collateral without the lender’s consent.
- A voluntary bankruptcy filing that interferes with the lender’s ability to foreclose.
- Environmental contamination the borrower failed to manage properly, which can expose personal assets to remediation costs.
Carve-outs generally fall into two groups. “Actual loss” provisions make you liable only for the lender’s provable damages tied to the triggering event. “Full liability” provisions convert the entire loan to recourse. Which category applies to which trigger is a matter of the specific loan language, which is why the carve-out section deserves close attention before closing.
Two Specialized Situations to Know About
If you hold the property through a partnership, non-recourse debt affects your outside basis. An increase in your share of partnership liabilities is treated as a contribution of money (raising basis), and a decrease is treated as a distribution (lowering it); your deductible losses are capped by that basis.11IRS.gov. Determining Liability Allocations For real estate partnerships, the share of non-recourse debt allocated to each partner is often what gives investors enough basis to use the depreciation that passes through to them.
If a self-directed IRA uses non-recourse financing to buy real estate, the debt-financed share of the income is subject to unrelated debt-financed income (UDFI) tax. The taxable fraction equals the average outstanding loan balance divided by the average adjusted basis of the property.12eCFR. 26 CFR 1.514(a)-1 – Unrelated Debt-Financed Income and Deductions So if the IRA puts 35% down and finances 65%, roughly 65% of the net rental income is taxable as unrelated business taxable income, paid out of the IRA, despite the account’s usual tax-exempt status.