Jim Porter: New CA law expands tax break for mortgage forgiveness
Special to the Sun
A newly enacted California law provides a tax break to residential borrowers whose mortgage debt is forgiven through a foreclosure, short sale or loan modification. This is good news.
If you were one of the lucky few who were able to get your lender to lower your loan balance and do a short sale, or if you were even more fortunate and were able to modify your loan and reduce the loan amount (I have yet to find that rare person), or if you were not so lucky and your home was foreclosed on, in each of those three scenarios your debt to the lender was not paid in full. The unpaid loan amount is and#8220;forgiveness of debtand#8221; which is generally taxable as income. Income you never received. You may have received a 1099 form. So in the case of a foreclosure, not only do you lose your home, you may have to pay taxes for the privilege of not having to pay your mortgage in full. Kicked while you are down.
Now thanks to Senate Bill 401, signed by Governor Arnold earlier this month, California taxpayer-owners of principal residences (generally owner-occupied) may exclude from their 2009-2012 income tax returns the amount of mortgage debt forgiven by the lender in those years on a short sale, foreclosure or loan modification.
The new law limits the amount of so-called and#8220;qualified principal residence indebtednessand#8221; (your loan) to $800,000 for taxpayers who file as married/registered domestic partners filing jointly, or single, head of household, and to $400,000 for taxpayers who are married filing separately. The maximum amount of debt relief is $500,000 for taxpayers in that first category and $250,000 for taxpayers who file as married filing separately.
So if husband and wife with a loan less than $800,000 pull off a short sale and the lender and#8220;takes a haircutand#8221; by reducing the mortgage by $200,000 to allow the sale to close, they would normally receive a 1099 and have a tax obligation. Now they will not.
SB 401, called the Conformity Act of 2010, extends and expands a similar law in California (2007-2008 tax years) which limits the qualified principal residence indebtedness to $800,000 for taxpayers in that first category and to $400,000 for taxpayers who are married filing separately, with debt relief capped at $250,000 for married/registered domestic partners filing jointly or single, head of household taxpayers and $125,000 for taxpayers married filing separately. The 2010 Act bumps those amounts for the tax years 2009-2012.
Federal law under the Mortgage Forgiveness Debt Relief Act of 2007 (taxable years 2007-2012) limits the amount of qualified principal residence indebtedness (your loan) to $2 million for taxpayers married filing jointly, or single head of household, and to $1 million for taxpayers who file as married filing separately. The federal law does not limit the amount of debt relief. Unlike California, there is no cap on how much forgiveness of debt you can take if you are within the loan limits.
Under both California and federal law, if your loan exceeds the amount of qualified principal residence indebtedness under either law, you do not qualify for any forgiveness of debt relief; at least that is how I understand it. Rich folks need not apply.
and#8220;Qualified principal residence indebtednessand#8221; refers to a loan secured by a primary residence used to acquire, construct or substantially improve the residence (which excludes a refinance or loan on a rental property or loan secured by your residence where the funds were used to pay bills or purchase a boat).
These tax-saving laws do not apply to debt forgiveness on a second home mortgage like a resort property or business/commercial property or investment property.
Apparently you file for debt relief on form 540 for a California resident. If you have already filed your tax return, file a form 540X. I say and#8220;apparently,and#8221; because Iand#8217;m not a tax attorney, in fact I barely know how to spell T-A-X (call the carrier), but I am counseling homeowners with upside down loans and tax consequences are part of that discussion.
These tax issues are complex, CONFER WITH A QUALIFIED TAX ADVISER. For more on SB 401, refer to the Franchise Tax Board website at http://www.ftb.ca.gov/aboutFTB/newsroom/Mortgage_Debt_Relief_Law.html .
Jim Porter is an attorney with Porter Simon, with offices in Truckee, South Lake Tahoe, Incline Village and Reno. He is a mediator and was the Governor’s appointee to the Fair Political Practices Commission and McPherson Commission, both involving election law and the Political Reform Act. He may be reached at email@example.com or at the firmand#8217;s website.