Dec. 4 – The CALIFORNIA ASSOCIATION OF REALTORS®’ (C.A.R.) announced today it received a letter from the California Franchise Tax Board (FTB), obtained by Board of Equalization (BOE) member George Runner, clarifying that California families who have lost their home in a short sale are not subject to state income tax liability on debt forgiveness “phantom income” they never received in a short sale.
Last month, in a letter to California Sen. Barbara Boxer, the Internal Revenue Service (IRS) recognized that the debt written off in a short sale does not constitute recourse debt under California law, and thus does not create so-called “cancellation of debt” income to the underwater home seller for federal income tax purposes.
Following the IRS’s clarification, C.A.R. sought a similar ruling by the California FTB. Now with the FTB’s clarification, underwater home sellers also are assured that they are not subject to state income tax liability, rescuing tens of thousands of distressed home sellers from California tax liability for debt written off by lenders in short sales.
“We are pleased with the recent clarifications issued by the IRS and the California Franchise Tax Board, which protect distressed homeowners from debt relief income tax associated with a short sale in California,” said C.A.R. President Kevin Brown. “We would like to thank Sen. Boxer and BOE member Runner for their leadership in obtaining this guidance from the IRS and FTB.”
“Distressed California homeowners can now avoid foreclosure or bankruptcy and can opt for a short sale instead, without incurring federal and state tax liability, even after the Mortgage Forgiveness Debt Relief Act of 2007 expires at the end of this year.”
“phantom income”
???
If you did a cash-out refi, I’d call that real income.
If you cash-out refi up to but not more than the original purchase price, not income. Any more, then income. That’s just my opinion. On the debt-tax relief, it seems to all hinge on recourse vs. non-recourse. State law says if Banks agree to short it, then it becomes non-recourse. State law says purchase money is non-recourse. State law says refi money is non-recourse if they do a non-judicial foreclosure. So what is left? Refi money with a judicial foreclosure? Would that be recourse and therefore also taxable? I think we have all heard whispers that some banks might give some judicial foreclosures in CA and go and see what happens… I’ll believe that when I see it though.
Agreed and I’m sure you feel like me and will expect to see flying pigs before the IRS or FTB starts auditing short sale tax returns looking to punish the cash-out folks.
I am still scratching my head over this.
IRS rules have always determined whether a debt is non-recourse by virtue of the way the debt is created, not the way it is canceled. Of course debt becomes “non-recourse” when it is canceled.
Not sure what legal effect a letter from an IRS district head to a senator and a FTB letter to a real estate interest group will have with the courts. It is not the type of authority one typically relies on as legal precedent.
I suspect this will not be as clear cut as CAR is suggesting it will be. We shall see.
Big win for the deadbeats and cash out crowd.