You might not remember, in 2007 the Mortgage Debt Relief Act was passed, helping homeowners who sold their home for less than what they owed.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. The amount of forgiven debt in a short sale would have been subject to taxes as ordinary income, the Mortgage Debt Relief changed this. Initially it ended December 2012 but was extended for an other year till December 2013. But what about next year? Some good news to report:
Recent announcement from C.A.R. :
C.A.R. has been working with California Sen. Barbara Boxer to protect distressed homeowners from debt relief income tax associated with a short sale in California. As part of this effort, Sen. Boxer requested the Internal Revenue Service (IRS) to provide guidance on whether mortgage debt forgiveness in a lender-approved short sale would be taxable income under federal law, given California’s recent non-recourse laws for short sales, which were hard fought victories by C.A.R.
The IRS has clarified in a letter that California’s troubled homeowners who sell their homes in a short sale are not subject to federal income tax liability on “phantom income” they never received. The IRS recognizes 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. This clarification rescues tens of thousands of distressed home sellers from personal liability upon expiration of the Mortgage Forgiveness Debt Relief Act of 2007 on Dec. 31, 2013.
C.A.R. is seeking a similar ruling from the California Franchise Tax Board (FTB), which has been awaiting the IRS action; C.A.R. anticipates the FTB will act promptly. Short sales may raise other tax issues and, as always, REALTORS® should advise their clients to speak with their tax professional regarding the tax consequences of a short sale. C.A.R.’s Legal Department has prepared a Realegal to further explain the IRS’s clarification.
– end announcement
Although the state tax is not as high as federal tax, we are eagerly waiting for the response of the Franchise Tax Board.
Coming from the Netherlands where it’s normal to pay appr. 60% income tax it was a relief to find out that taxes are much lower here, yet paying taxes on mortgage debt that is forgiven is difficult since the one reason that you do a short sale is to avoid foreclosure, not a time of financial prosperity.
As mentioned many times, a short sale is a gracious alternative to foreclosure on so many levels, please consult a good realtor should you face a foreclosure or have a need to sell while still owing more than your house is worth.
Besides this, enjoy the beauty of nature that surrounds us, take a hike and let the sunset take your breath away…
P.S. Thank you Mathew Schweifler
for helping with the research for this blog posting 😉