Informing Yourself about 2014 Short Sale Laws
If you’re a homeowner, it’s vital that you make yourself knowledgeable about the new 2014 Short Sale related laws. The California Franchise Tax Board has clarified California homeowners who have lost their primary home in a short sale situation are not subject to California state income tax liability for debt forgiveness “phantom income” that they did not receive during the short sale on their primary residence on a non-recourse loan.
With a non-recourse loan the lender’s only available course of action during a default situation is to repossess the property being financed or used as collateral. Meaning the lender cannot pursue you directly in case of default. The forgiveness of debt on a non-recourse loan that results from a foreclosure does not result in cancellation of debt income, but it may result in other tax consequences.
Completing a short sale can be one way for California homeowners to now avoid foreclosure or bankruptcy without incurring California state tax.
Under California law, the IRS recognizes that the debt written off in a short sale does not constitute recourse debt. And thus does not create so-called “cancellation of debt” income to the underwater California home seller for federal income tax purposes. Which means that even with the Mortgage Debt Relief Forgiveness Act’s expiration, there may not be a taxable event as a result of your short sale with a loss. You may be able to short sale your primary home in California without incurring both state and federal income tax for completing a short sale on non-recourse loans.
You must check to see if you qualify to avoid the tax if you have converted your primary residence to a rental property in the last 5 years but have lived there 2 years out of those last 5 years.
IRS Website is a Helpful Resource
It might also be helpful to visit the IRS website for more information on the Mortgage Debt Relief Forgiveness Act and Debt Cancellation.
Consult the Professionals
It might also be in your best interest to seek the advice of a real estate attorney as well as a tax professional to see how these laws might apply to your specific situation.