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Tax Relief on Forgiven Debt Set to Expire

Short Sale

State and Federal Tax Relief on Foregiven Debt Set to Expire.

According to the IRS , “If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.” For example, you borrow money from a commercial lender to purchase your primary residence and the lender later cancels or forgives the debt by way of a short sale, you may have to pay taxes on the cancelled debt amount. Thankfully, Congress enacted the Mortgage Forgiveness Debt Relief Act of 2007 on December 20, 2007 . The Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence from federal tax liability. California’s tax treatment of mortgage debt relief income generally aligns with federal law and consequently debt forgiven on a loan secured by a “qualified principal residence,” are presently exempt from both federal and state income tax.  The existing federal exemption is for indebtedness up to $2 million, whereas the new California exemption is for indebtedness up to $800,000 and forgiven debt up to $500,000, but only until Dec. 31, 2012. Unless Congress and the California State legislature take action, the tax break for mortgage principal forgiven in loan modifications or short sales will expire at year’s end.

Those considering short sales or loan modification whom do not wish to incur any subsequent federal or state tax liability upon debt forgiveness, would be wise to act now so as to mitigate tax liability and take full advantage of administration’s other incentives. For example, the HAFA program offers $3,000.00 to distressed home owners for relocation assistance. Under HAFA short sale home owners work with the lender to price and market the your property. Short sellers are given 120 days to sell the property during which the lender must postpone foreclosure proceedings. MHA programs, such as HAFA, end in December 2013. A California state based equivalent is TAP (Transition Assistance Program). The Transition Assistance Program provides one-time funds to help eligible homeowners relocate into a new housing situation after executing a short sale or deed-in-lieu of foreclosure program. The TAP can provide up to $5,000 in transition assistance per household. In cases where the servicer has approved the homeowner for a HAFA transaction, TAP dollars will be limited to $2,000 in order to maintain the $5,000 HHF program maximum per household.

The American Taxpayers Relief Act of 2012 was signed into law on Jan. 2.  The law includes a provision to extend the Mortgage Forgiveness Debt Relief Act, which will for one more year exempt the taxation of mortgage debt that is forgiven when homeowners and their mortgage lenders negotiate a short sale or loan modification (including any principal reduction).  However, the California exemption expired at the end of 2012, so forgiven mortgage debt is considered taxable state income for now. Currently, C.A.R. is sponsoring SB 30 (Calderon, D-Montebello).  SB 30 will conform state law to the federal law passed earlier.  Upon passage of SB 30, the measure will be effective retroactive to Jan. 1, 2013.

For more information on short sale assistance or other alternatives to foreclosure, please see our short sale page and or contact us for free consultation.

The content provided does not constitute legal/tax advice and is not intended to constitute advertising or solicitation for legal/tax services. Nothing in this Site should be construed by you as a source of legal/tax advice. You should not rely or act upon the contents of this Site without seeking advice from your own attorney/tax specialist. This information is provided for general information purposes only. IRS Circular 230 notice: In order to comply with requirements imposed by the IRS, we must inform you that any U.S. federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog.

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