no tax due
When the Mortgage Forgiveness Debt Relief Act expires on January 1, 2014, tens of thousands of homeowners will feel the tax hit. Not so for people in California.

The Mortgage Forgiveness Debt Relief Act exempts from taxation the mortgage debt that is forgiven when homeowners and their mortgage lenders negotiate a short sale, loan modification or foreclosure.

Passed into law on December 20, 2007, the act applied to debts discharged in calendar year 2007 through 2009. Relief was extended twice (once in 2008 and again in 2012) and will finally expire on January 1, 2014.

The law has helped hundreds of thousands of homeowners deal with the foreclosure crisis; in fact, over 400,000 in 2012 alone according to data by RealtyTrac.


California Law Protects Homeowners After Foreclosure

In California, mortgages are considered to be non-recourse – that is, homeowners aren’t personally liable for the unpaid balance after foreclosure.

This California rule made the federal mortgage forgiveness rules largely a non-issue, but the expiration of the federal law led California homeowners to wonder whether they wouldn’t lose their state-based protections.

IRS Confirms That Taxpayer Protections Remain In Place

Senator Barbara Boxer, seeking guidance on the issue, asked the Internal Revenue Service and the California Franchise Tax Board to confirm that California homeowners wouldn’t suddenly be left with a tax burden after foreclosure or short sale.

The Internal Revenue Service confirmed that debt written off in a short sale does create “cancellation of debt” income to the underwater home seller in California. The California Franchise Tax Board also confirmed the same position in a letter sent to Boxer’s office.

Thankfully, taxpayers in California have the continued protection of state law even in the face of expiration of the federal protections.

If you’ve done a short sale or gone through a foreclosure in California, remember to alert your accountant or tax preparer. An improper Form 1099 could have a dramatic effect on your tax liability.