tax impact of debt relief from short sale or foreclosure

This was passed to me by Asset Exchange Company , a 1031exchange company.

Taxes on Short Sales and Foreclosures

According to the IRS, "if you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable."

The good news is that the Federal government has provided some relief in the form of The Mortgage Forgiveness Debt Relief Act of 2007. The highlights of this Act are as follow:

  • The Act applies only to forgiven or canceled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.
  • The debt must be secured by the home.
  • Exclude up to $2 million of debt forgiven or canceled by a mortgage lender on a primary residence.
  • Both mortgage restructuring and foreclosures qualify
  • Available for the years 2007 through 2012.
  • Claim the tax relief using IRS Form 982 (download here)
  • The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt

Unfortunately, as of the date of this newsletter, the state of California is not in line with the Federal government regarding this issue. According to the California Franchise Tax Board, "For tax year 2009, California does not conform to the federal Mortgage Forgiveness Debt Relief Act which applies to discharges occurring in 2007 through 2012. Amounts excluded for federal income tax purposes must be added to income for California tax purposes."

This means debt relief is taxable at the state level. There is a bill pending in California to mirror what the Federal government has done, but it has not yet been signed in to law.


Sunil Sethi / Broker, President, REALTOR, MBA / SUNIL SETHI REAL ESTATE

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