Stories in the news indicate that you may owe taxes on the price difference between your original home loan and the short-sale price.
Excerpted from The Chronicle, Mrach 15, 2010
California has been counting the difference between the original home price and the sale price as part of the seller’s income, resulting in a hefty state income tax bill.
For example, when the Blackwells sold their $825,000 Fairfield house at a shortsale price about half of that, they learned that California is counting the difference as income and wants $38,000 (in extra taxes).
That is insane and illogical, no matter how it is viewed. The Blackwells did not make a profit, there was no money to pocket, the loan was probably 30-year-loan, which means NO one would have realized the total income from the property for 30 years, so why on earth would any ethical entity bill them for that spread? This begs the question, since they sold their home at a loss, wouldn’t that go into their year-end tax report as a $400,000+ loss, in which case wouldn’t that offset their California tax bill of $38,000? I think these people need a good accountant.
California legislators last week passed a bill that would fix the situation. It mirrors a federal law that excludes “forgiven debt” on a principal residence from being considered taxable income. It covers short sales, foreclosures, deeds in lieu of foreclosure and loan modifications that reduce the principal due.
However, Gov. Arnold Schwarzenegger, who has until March 23 to sign the bill, indicated that he is likely to veto it based on an unrelated provision regarding tax fraud.
“It was a shock to me to discover that California tax rules (for foreclosures and short sales) did not conform to what the federal government has done,” said state Sen. Lois Wolk, D-Davis, who sponsored the legislation. “These people have suffered enough. To consider the decline in the value of their loans as income, that’s unacceptable.”
Expiration dates
When the foreclosure crisis started, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 so foreclosed homeowners would not be liable for their canceled debt. It is in force through 2012. California had a similar law, but it expired at the end of 2008, leaving Californians who lost their homes in 2009 potentially liable for big state tax bills.
In the nine-county Bay Area, 27,530 homes were repossessed as foreclosures and 9,522 were sold as short sales in 2009, according to data compiled by ZipRealty.
Tax experts advise people who lost their homes in 2009 to file for an extension in hopes that California will rectify matters.
Several other pending bills would align the state with federal tax law, and Schwarzenegger has indicated that he would sign a bill that focuses only on this issue. “The governor is supportive of a clean tax-conformity bill,” said Mike Naple, a spokesman for his office.
People who lost their homes to foreclosure or short sale may still have some tax liability at both federal and state levels, though.
A Homey ATM
“Many people used their house like an ATM machine,” said Steve Moskowitz, a San Francisco tax attorney. “If the debt is forgiven, those people find themselves in problems with the IRS unless they qualify for an exception because of bankruptcy or insolvency,” that is, their liabilities outweigh their assets.
Experts emphasize that it’s crucial for people contemplating foreclosure or short sale to get tax and legal advice well in advance of taking any action.
“At the very least they will have a clear picture of the tax consequences they will be facing,” Comstock said. “There are many circumstances when getting advice from a tax pro before the event can mitigate the unpleasant tax consequences.”
‘Forgiven debt’ rises
Banks that forgive consumer debt in the United States report it to the IRS through two forms:
- 1099-A covers foreclosed properties; the number being filed more than doubled last year.
- 1099-C covers foreclosures, short sales, loan modifications, credit cards and other debt.
- Form 2009 (projected) 2008 2007
- 1099-A 1,856,300 873,081 467,656
- 1099-C 2,521,900 1,987,035 1,696,396
Source: Internal Revenue Service
Information on forgiven debt and taxes:
- California: links.sfgate.com/ZFRZ
- Federal: links.sfgate.com/ZJJL
- Video: links.sfgate.com/ZJJM
Read more: at www.sfgate.com
