California Short Sale Sellers May Face Big Tax Bills if the Legislature Can’t Get on the Ball

When selling a home as a short sale, there can be both legal and tax consequences to the seller.

If the bank forgives debt, the seller will get a 1099 from the bank, showing the forgiven debt as income.  Whether or not the seller will have to pay taxes on this “income”, depends upon the situation.

Under the 2007 Federal Debt Forgiveness Act, if the debt is forgiven between 2007 and 2012 and is on a principal residence, it may be forgiven. This forgiveness applies if the debt was used to buy, build or substantially improve a home or to refinance the debt for the above items.  The debt may also be forgiven if it’s non-recourse debt, meaning the lender cannot pursue the borrower personally after a default and/or foreclosure.

However, California currently does not follow the federal model.  It modeled the Federal code in 2007 and 2008  but did not pass an extension for 2009. Therefore, currently, a California short sale seller may be responsible to pay state taxes on debt forgiven on a California short sale.

Governor Schwarzenegger has refused to sign a bill that would model the Federal model because it has unrelated provision that he will not sign. He has asked the legislature to pass a separate bill that would deal solely with the forgiveness of debt issue. However, it has not yet been passed.

Watching the suffering so many families are going through as I help them with short sales, I can only hope that California’s government can put aside their differences to help people desperately in need rather than allowing their divisiveness to allow further harm to come to these people who are already in distress and leaving them further adrift in financial difficulties.

I am not a tax expert, and I am not offering this information as advice, either tax or legal.  I strongly recommend speaking with a CPA and/or an accountant when making a decision if you are at risk of losing your home.

If you would like to discuss your options when facing foreclosure, please contact me at 714.319.9751.