First, ALWAYS check with your own tax professional as there is still much confusion on the short sale debt relief at both the federal and state level. This blog or others, can NOT be a substitute for qualified advice from your CPA or tax attorney.
One of the most commonly asked questions of me on my blog and website is whether or not the Mortgage Debt Relief Act has been extended, and if California has followed suit.
You may all recall, that in 2007 the Mortgage Debt Relief Act came into existence and was meant to offer relief to homeowners in distress, doing a short sale, selling their home for less than their mortgage balance(s). Prior to the act, it was said that the difference between what you sold the home for (what the bank settled for in a short sale) and what WAS owed on your loan was phantom debt, cancelled debt and subject to INCOME TAX! Income tax on money you never got, never benefited from. You got a 1099 form from the bank you had to address with the IRS in the January following your sale. Bam! Not very nice. Well, the Mortgage Debt Relief Act was meant to relieve homeowners by clarifying that cancellation of debt income on a primary residence may not be applicable. Good news. And shortly after, California Franchise Tax Board followed suit.
The federal debt relief act was set to expire in 2012, but it was extended to December 31, 2013. BUT California DID NOT follow suit in 2013 so it’s been very stressful for California homeowners who conducted a short sale in 2013. We just got some good news.
I want to say first, don’t take any blog or real estate professionals word for it. YOU MUST speak to your CPA, tax professional or attorney about your particular situation. Every situation is different, and real estate professionals are usually not also a CPA or attorney and advice about your taxes must be obtained from a qualified tax professional.
But here is the good news for 2014, these recaps are excerpted directly from our California Association of Realtors Alerts (link):
FEDERAL DEBT RELIEF INCOME TAX FOR SHORT SALES
A short sale in California is generally not subject to federal income tax for mortgage debt forgiveness, according to a recent letter from the Internal Revenue Service (IRS). C.A.R. worked closely with Senator Barbara Boxer to obtain this IRS guidance. We are also hopeful that we can promptly obtain similar guidance regarding state income tax for mortgage debt relief income from the California Franchise Tax Board (FTB), which has been awaiting this IRS letter. Given that a homeowner in California generally cannot be held personally liable for a short sale deficiency (see below), the IRS stated in its letter that it would consider the mortgage loan as a nonrecourse obligation that is not subject to federal debt relief income tax. The amount of indebtedness, however, must be reported as the amount realized for capital gains purposes. Of course, a principal residence is generally excluded from capital gains tax up to $250,000 for single taxpayers and $500,000 for married couples filing joint returns (under 26 U.S.C. § 121).
State – Franchise Tax Board
California homeowners who lost their home in a short sale will not be subject to federal or state income tax liability on debt forgiveness “phantom income” they never received, thanks to recent clarifications by the Internal Revenue Service (IRS) and California Franchise Tax Board (FTB). In November, in a letter to California Sen. Barbara Boxer, the Internal Revenue Service (IRS) recognized that the debt written off in a short sale does not constitute recourse debt under California law, and thus does not create so-called “cancellation of debt” income to the underwater home seller for federal income tax purposes. Following the IRS’s clarification, C.A.R. sought a similar ruling by the California FTB, with the help of the Board of Equalization (BOE). Now with the FTB’s clarification, underwater home sellers also are assured that they are not subject to state income tax liability, rescuing tens of thousands of distressed home sellers from California tax liability for debt written off by lenders in short sales. We thank Sen. Boxer and BOE member George Runner for their leadership in obtaining this guidance from the IRS and FTB. Distressed California homeowners can now avoid foreclosure or bankruptcy and can opt for a short sale instead, without incurring federal and state tax liability, even after the Mortgage Forgiveness Debt Relief Act of 2007 expires at the end of this year.
From CAR: The IRS guidance is limited to California short sales only. The IRS guidance did not specifically address other types of real estate transactions such as non-judicial foreclosures and mortgage loan modifications.
Contact Catherine Myers, Real Estate Broker for help with a short sale in Contra Costa and the San Francisco Bay Area. Short sales are still happening as some of our areas took huge value plunges and in some areas, they may not recover to the levels needed to sell the home without being a short sale. Catherine can guide you through a short sale, get you the help you need, and get you moved on to the next chapter. Whether your situation is financial, unemployment, relocation or personal, most banks are well equipped to handle a short sale and can take anywhere from 4-12 weeks to complete. Call today 925-683-2125.