Per the IRS site, if you borrow money and the lender later cancels or forgives the debt, you may have to include the cancelled amount as income for tax purposes, depending on the circumstances. Yes, the debt forgiven by the lender might be taxed like ordinary income and this is just too much of a burden on top of the loss of the home. In 2007 the government passed The Mortgage Debt Relief Act of 2007. This was a blessing for homeowners who needed to sell their home short because it generally allowed taxpayers to exclude income from the discharge of debt on their principal residence. This Mortgage Debt Relief Act expired on December 31, 2012 and then was extended only through December 31, 2013. The State of California followed the federal government and forgave this debt for California taxes through December 31, 2012. For all of 2012, homeowners who sold short have been worried about the California Taxes. And after December 31, 2013? Will these taxes be due for both federal and state incomes taxes?
There are still many homeowners who need to sell their home below market value. Paying taxes on the forgiven debt has been and is a huge concern. THE GOOD NEWS! I am excited to say I received an update from the California Association of Realtors (CAR). Here is the gist of the update: CAR received a letter from the California Franchise Tax Board, which clarified California owners who lost their home in a short sale are not subject to state income tax liability on debt forgiveness they never received in a short sale. And per this update the IRS sent a letter to Sen Barbara Boxer stating debt written off in a short sale doesn’t constitute recourse debt under California law, and thus doesn’t create “cancellation of debt” income to the underwater home seller for federal income tax purposes.
To read more about this please click on this link:
It is also important to note I am not an accountant and cannot give tax advice so please check with your trusted tax and accountant advisor about your particular circumstances.
Written by Laurie Whitton