The HOT topic for real estate that everyone was talking about coming up to the new year is official, but with an asterisk regarding the extensions of the Mortgage Forgiveness Debt Relief Act and American Taxpayer Relief Act. This is a little lengthy article, but worth your extra 15 minutes to digest. While federal government has extended the tax law, California to this date has not extended their tax law, but more importantly the Mortgage Debt Forgiveness has been definitely extended. What does all this mean to you and your situation, whether owner-occupied or an investment property that is upside down and you’re wanting an answer to what you have to do, CALL ME for help. Letting a property go to foreclosure or doing a Deed in Lieu could put you in a liability situation for all the debt of a Trust Deed. I work with CPAs and attorneys that can help. After over 20 years of short sales, hundreds closed, you owe it to yourself to only talk to the BEST! CALL NOW! JOHN A SILVA — 619-890-3648. MAKE IT YOUR BEST YEAR!
III. Extension of Mortgage Cancellation of Debt Relief
Q 4. What is mortgage cancellation of debt relief?
A. As a result of a foreclosure on a recourse loan, a short sale or a deed in lieu of foreclosure, a lender may cancel, reduce or forgive the debt that the borrower owes on the loan. The IRS and the California Franchise Tax Board consider this cancelled or forgiven debt as income to the borrower. As a result, the forgiveness or cancellation of the whole or a portion of the loan balance, often termed “cancellation of debt income,” may result in a tax liability.
The cancellation of debt income is generally treated as “ordinary income,” as opposed to capital gains income which is taxed at a lower rate, and the taxpayer will typically receive a 1099 tax form from the lender in the amount of the cancellation of debt.
Under the tax law there exist various situations where the cancellation of debt income is not taxable including bankruptcy, insolvency and when there is a foreclosure on a non-recourse loan. However, for most homeowners involved in a short sale, foreclosure or deed in lieu of foreclosure, the tax relief provided by the Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) signed by President Bush on December 20, 2007 and subsequently extended by the Emergency Economic Stabilization Act of 2008, provides the most important protection against having to pay tax on the cancellation of debt income.
As a result of the Mortgage Forgiveness Debt Relief Act of 2007, Internal Revenue Code §108(a)(1) (E) was added and provides that a taxpayer will not be taxed upon cancellation of debt income if the following conditions are met:
The property sold in the short sale is the taxpayer’s principal residence, as that term is used in IRC §121.
The cancellation of debt is Qualified Principal Residence Indebtedness under IRC Section 163(h)(3)(B). Qualified Principal Residence Indebtedness is a loan secured by the residence used to acquire, construct or substantially improve the residence. The income relief provided is capped at $1,000,000 in the case of a married person filing a separate return and $2,000,000 for all others. Any reduction of indebtedness excluded by IRC §108(a)(1)(E) will be applied to reduce the basis of the taxpayer’s principal residence, but not below zero. This could result in a higher amount of capital gains tax owed by the taxpayer. Also the cancellation of debt relief provided by the law, therefore, does not apply to any portion taken as “cash out” and not used to substantially improve the residence.
Q 5. How does the American Taxpayer Relief Act affect the mortgage cancellation of debt relief?
A. The original law applied to indebtedness discharged before January 1, 2010. That end date was extended by three years from 2010 to 2013 pursuant to H.R. 1424, the Emergency Economic Stabilization Act of 2008. The new law extends the date one year further to any indebtedness discharged prior to January 1, 2014.
Q 6. Does the federal law apply to potential cancellation of debt income under California tax law?
A. No. California has its own cancellation of debt relief law which has been codified as California Revenue and Tax Code Section 17144.5 which is similar to the federal law but with some significant differences (see next question). That law has expired. However, C.A.R. has sponsored Senate Bill 30 (Calderon, D- Montebello) to extend California’s debt relief protections which is currently pending. The proposed law would be effective retroactive to January 1, 2013. Information on the status of the bill can be found at www.leginfo.ca.gov.
Q 7. What are some of the differences between the state and federal law on cancellation of debt on qualified principal residences?
A. California law has different limits for maximum indebtedness and the amount of cancellation of debt income that can be forgiven which are detailed below:
The maximum amount of qualified principal residence indebtedness is $800,000 for married couples filing jointly, registered domestic partners filing jointly, single persons, head of household, or widow/widower; and $400,000 for married couples or registered domestic partners filing separately;
The maximum amount of debt relief income that can be forgiven is $500,000 for married couples filing jointly, registered domestic partners filing jointly, single persons, head of household, or widow/widower; and $250,000 for married couples or registered domestic partners filing separately.
This is an excerpt from California Association of Realtors Legal — Part 2 coming next week will be on Taxation of Foreclosures and Short Sale.