California Legislature approves tax break for people in foreclosures, short sales

By | April 10, 2010

California Legislature approves tax break for people in foreclosures short sales

Reporting from Sacramento — Thousands of Californians whose homes were foreclosed on or sold at a loss would get tax relief under a measure approved Thursday by the state Legislature.

The bill would waive state taxes on mortgage debt that has been forgiven in a foreclosure or short sale. It is expected to affect about 34,000 taxpayers.

Gov. Arnold Schwarzenegger said he would sign the measure, which would also provide about $60 million in tax credits to green-energy companies, when it reached his desk. Californians can already claim the tax breaks on federal returns. Lawmakers passed the measure in time for people to take advantage of it by the April 15 deadline for filing tax returns.

“The mortgage-debt tax relief provision in this bill will provide financial shelter for tens of thousands of Californians who have lost their hopes and dreams in the housing market crash, and it’s about time we gave these folks a helping hand,” said state Sen. Ron Calderon (D-Montebello). …

“It’s an issue of fairness,” said Sen. George Runner (R-Lancaster). “You are giving money to one group of people and taking it away from another group of people.”

With the plunge in the real estate market, many Californians have found themselves owing much more on their mortgages than their homes are worth. Some have been foreclosed upon or asked their lender to approve a short sale, in which a home is sold for less than the debt, some of which is waived.

The amount waived has been considered taxable income under California law. The measure passed Thursday would eliminate that tax when a bank agrees to accept less than what is owed on a home.

The governor vetoed a similar bill last month because it included a provision, since removed, that would have increased penalties against businesses and wealthy individuals who abuse tax credits …

Schwarzenegger said during a news conference Thursday that he wants to give homeowners and businesses “the relief they need.”

“We want to be helpful in every way we can, so we will sign it,” he said. …

via California Legislature approves tax break for people in foreclosures, short sales – Los Angeles Times.

SB 401 also conforms California tax law to the federal Mortgage Forgiveness Debt Relief Act, an important provision that ensures that the state does not tax individuals on their debt cancellation income resulting from mortgage forgiveness. For example, a taxpayer with a recourse mortgage with a $500,000 loan enters into a short sale to sell the home for $300,000, resulting in $200,000 in debt forgiveness. Under current California law, the taxpayer must report $200,000 in income, and pay taxes on that amount. SB 401 conforms to the federal law, forgiving the income up to specified amounts. The measure retroactively applies to the previous taxable year, ensuring that individuals with cancellation of indebtedness income from short sales in 2009 are not hit with a big tax bill. – senweb03.sen.ca.gov

California’s  governor needs to sign off on SB 401 by April 15 to make the exemption possible for people who are assuming tax liabilities on the difference between the original mortgage balance and the adjusted sales price. With only about 35,000 mortgages adjusted last year, and about 500,000 notices of default, SB 401 would help a lot of Californians who never thought they would lose their homes. – realstory

What do I do to take advantage of  SB 401 on my taxes? I never got a 1099-C form, but I figured out my canceled debt income by using the purchase price as the basis (I had no improvements other than the several thousand I put in to repair the carpet, but that doesn’t count). Then I used the amounts the bank got to pay off the first and second loans and subtracted those from the purchase price to find my debt forgiveness income.  That amount goes on form 982 as canceled debt and in my case this income was excluded based on the fact that this was my principle residence. So, for the Federal form, I  complete form 982 and put zero, “0”, on line 21 of my 1040 and write “Cancelled Debt – see form 982”.  Then attach that form. It comes with the tax software I’m using. For the state, I’m not sure if I need to do anything since I did not get a 1099. I suppose I do, but I’m not sure how SB 401 changes what I submit.

Anyone know? Ah, here is something:

(Updated 4/7/2010) Generally if you have property that is used as security for a debt and that property is taken by the lender (foreclosed) in full or partial satisfaction of the debt, you are treated as having sold the property.

This may generate either a gain or a loss, and in some cases cancellation of debt (COD) income. …

Tax year 2009: California does not conform to the federal Mortgage Forgiveness Debt Relief Act…

If you qualify to exclude COD [Cancellation of Debt] income in 2009 based on one of the provisions described in the California law section above, complete federal Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), using California law and attach it to your California tax return. There is no similar California form.

If you are using the same exception for both federal and California purposes, a separate form is not needed.

IRS publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, has a worksheet that can be used to help calculate the extent to which a taxpayer is insolvent immediately before the cancellation.

See the IRS website for publications, forms, and more information about home foreclosure and debt cancellation.” – ftb.ca.gov

Well… I guess I should see if I qualify as insolvent (does a 403b retirement fund count?) and if so, then I’m good. If not, I’ll have to figure out how much I would owe (gulp) and then hope the governor signs SB 401 before the 15th. If he does, I’ll just … let my TaxAct software get the state portion filled out correctly based on the federal form.

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