The California Association of Realtors yesterday issued a press release stating that, as a result of recent rulings by the Internal Revenue Service and California Franchise Tax Board, mortgage debt forgiven in a California short sale is no longer taxable as income.
This is huge news, since the tax exemption for this income tax was scheduled to expire on December 31, 2013 when the Mortgage Debt Relief Act expired. Without these rulings from IRS and FTB, California homeowners whose short sales did not close by year end were facing potentially enormous tax liability.
The IRS ruling was contained in a letter to Senator Barbara Boxer. The FTB ruling was in a letter obtained the C.A.R. from Board of Equalization member George Runner.
The rationale for the rulings appears to be that debt forgiven in a short sale is not considered “recourse” debt under California law, thus exempting it from taxation.
The C.A.R. press release does not state whether this ruling also will apply to short sale of non-primary residences in California, or if it is limited to only certain types of mortgage debt. I have requested my tax experts to review the actual letters and updated regulations to clarify these issues; I will provide that response immediately upon receipt.
At this point, it appears that similar protections will be extended to homeowners whose properties are foreclosed after December 31, 2013 where the debt forgiven was used to buy, build, or make substantial improvements to a primary residence. It does not appear these protections will apply to “deed in lieu” transactions.
California homeowners with pending short sales may breathe a sigh of relief. For these folks, it would appear that Christmas came a few weeks early this year.