Short Sale Information and Favorable Laws for California Homeowners in 2014

Here are the Short Sale related laws you should know about as a homeowner in 2014. Please seek the advice of a real estate attorney and a tax professional on how these laws apply to your specific situation. The good news in 2014 is that the California Franchise Tax Board has clarified that California families who have lost their primary home in a short sale are not subject to California state income tax liability on debt forgiveness “phantom income” they never received in a short sale on their primary residence (1-4 units) with a non-recourse, purchase money loan. A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Please read the IRS letter to Senator Boxer clarifying whether a California homeowner would have taxable cancellation of indebtedness income on a lender approved short sale that qualifies under section 580e of the California Code of Civil Procedure (CCP).

Most California homeowners can now avoid foreclosure or bankruptcy and complete a short sale instead in 2014. Even with the Mortgage Debt Relief Forgiveness Act’s expiration, there may not be a taxable event as a result of short sale with a loss, due to the IRS recognizing 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 California home seller for federal income tax purposes. This means that you may be able to short sale your primary home in California in 2014 and not incur both state and federal income tax for completing a short sale on non-recourse, purchase money loans. Please be sure to consult your tax advisor and legal professional on how these laws affect your specific situation. If you have converted your primary residence to a rental property in the last 5 years, however, you have lived there 2 years out of the last 5 years, please check with your CPA to see if you qualify to avoid the tax on a short sale on a converted rental property. Also be sure to read below on “Is cancellation of debt always taxable?”. You may also visit the IRS website here for more information on the Mortgage Debt Relief Forgiveness Act and Debt Cancellation.