By Steve
News has been flying around the Internet based upon a recent IRS letter released by Senator Barbara Boxer and the California Assn. of Realtors stating that they would not be taxing debt forgiveness on short sales. Today, we’ll look at that news and the rationale behind it.
Debt Forgiveness occurs whenever a property is transferred and the lenders are not paid in full... such as in a Short Sale or a Foreclosure. Under our nation’s Federal Tax Code, the IRS considers the amount unpaid as being taxable income (technically called “Cancellation of Debt Income”). In 2007, Congress passed the 2007 Debt Forgiveness Relief Act (the “Act”) which gave an exemption from this tax under certain conditions… primarily if the property was the debtor’s personal residence. California followed with a similar law. Throughout 2013, one of the most important topics on the minds of upside-down property owners was whether Congress would extend the Act beyond its 12/31/13 expiration date. California posed an even greater question since, due to political game playing, CA didn’t even offer the tax relief for 2013!
Significantly, unrelated to the tax issue, on July 15, 2011 California passed a new law commonly called “SB458″ which became CA Code of Civil Procedure Sec. 580(e). This law solely dealt with anti-deficiency liability after short sales and simply said that no lender could have recourse against a borrower after a short sale, ie: it became “non-recourse”. This law will continue operating after 12/31/13. Although 580(e) had nothing to do with debt forgiveness taxes or the Act, events in 2013 connected the two by raising the question of whether another IRS exemption for “non-recourse” debt might apply.
Realizing that Congress was not moving forward on extending the Act and that California had blocked the tax relief for 2013, last August California Senator Barbara Boxer sent a letter to the IRS asking whether there would be taxable income on a short sale under CA CCP Sec. 580(e). On September 19th, the IRS sent her a response that stated: “We believe that a homeowner’s obligation under the anti-deficiency provision of section 580e of the CCP would be non-recourse obligation to the extent that, for federal income tax purposes, the homeowner will not have cancellation of indebtedness income. Instead, the homeowner must include the full amount of the non-recourse indebtedness in amount realized”.
This was and is great news and appears to be …read more
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