July 19, 2011
Mortgage Relief Bill: Tax Consequences of Home Foreclosures and Short Sales
The California Association of REALTORS (C.A.R.) declared “victory” upon the Senate passage of SB 1178 on June 3, 2010 (the mortgage relief bill now moves to the Assembly for approval). Should this bill become law, California real estate agents should be cautioned to read the legislation very carefully because the protections afforded will be very narrow in scope.
Upon the foreclosure or short sale of a piece of real estate, the lender with the deficiency will issue a Form 1099-C, Cancellation of Debt to both the taxpayer and the IRS. In past years, the amount of cancelled debt would give rise to what is sometimes referred to as “phantom income”. This phantom income would be taxable as ordinary income and would result in tax that had to be paid by the taxpayer. The taxpayer however, having never taken actual receipt of any cash, would many times be unable to pay the tax this phantom income produced.Fortunately for taxpayers, Congress addressed this very issue in The Mortgage Forgiveness Debt Relief Act of 2007.
As C.A.R. explains in its “RED ALERT” announcement, SB 1178 is meant to extend the anti-deficiency protections found in 580b to homeowners who have refinanced purchase money loans and are now facing foreclosure. What is left unsaid from the announcement is that the protections in the proposed law are limited to the amount of the original purchase money loan.
While the State of California does not conform exactly to Federal law, it also provides relief from tax on forgiven mortgage debt for calendar years 2007 and 2008. Senate Bill 1055, enacted September 25th, 2008 allows taxpayers to exclude up to $250,000 of cancellation-of-debt income resulting from a discharge of a loan that was used to acquire, construct, or substantially improve the principal residence of the taxpayer. The maximum amount of a loan eligible to be excluded is $800,000. The exclusion is further phased-out for discharged loans that exceed $800,000. Some taxpayers may need to file an amended California return for 2007 in order to take advantage of these provisions. Doing so may result in a refund or reduction of tax liability.
Debts discharged in bankruptcy are not considered taxable income. The last option to avoid paying taxes would be to show that the homeowner is insolvent. To do this you would have to show that the amount of your debts exceed the amount of your assets.Losing a home to foreclosure can be a traumatic event. Being stuck with a tax bill can make things even worse. Thanks to recent legislation most homeowners should not get a notice from the IRS after losing a home to foreclosure.
Learn more about Obama Mortgage Relief Plan Qualifications.
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