Many Californians Faced with High Taxes on Mortgage Debt Forgiveness

Home foreclosures and the resulting banking mess it can lead to has money homeowners facing what is known as mortgage debt forgiveness. While it may sound like a good thing, many homeowners do not realize that mortgages debts, which are forgiven or cancelled may be counted as income and subject to taxation. This is especially true in California where a battle between the Governor and state lawmakers is heating up.

Some homeowners caught in the subprime mortgage crisis were offered a helping hand, however, in the passage of The Mortgage Debt Forgiveness Debt Relief Act of 2007. The legislation allowed for a three year exception for debt forgiveness on home loans.

Debts that are forgiven in connection with home foreclosure, and mortgage restructuring qualify for the relief. The law varies by state, and some place stricter provisions for mortgage forgiveness.
In California, however, the laws on mortgage debt relief fall under state provision. Debt forgiveness occurring on or after January 01, 2009, no longer conforms to federal provision as non-taxable. Instead, the amount of debt released is considered taxable to the state of California.

The state treats home loans as non-recourse debt, that is, if the home is foreclosed upon, the homeowner is seen as having sold the home for the amount of outstanding debt. Whatever the difference in the mortgage debt and the homeowner’s basis in the house counts as the gain or loss in actual sale.

If there is a ‘profit’ from the foreclosure, and the property is the principal residence for at least two of the past five years, than the gain may be eligible for gain exclusion on the sale. Conversely, if there is a loss, it may not be taken because it is a person’s primary residence.

The issue is a pressing one for Californians. Because the debt remaining on a short sale or foreclosure is taxable to the state, many Californians are faced with huge tax bills on top of losing their homes. Currently, Governor Schwarzenegger has threatened to veto the tax forgiveness bill because of a provision in the bill relating to tax fraud penalties for businesses.

Schwarzenegger wants that provision to be excluded from the bill or wants a separate bill drafted altogether which deals exclusively with the mortgage legislation. Democrats, however are dragging their feet on the issue.

The bill is to be signed next month. If it isn’t many California residents would face hefty state taxes. This has left many short sellers stuck between a rock and a hard place. Nearly 16,000 people are to be affected by the legislation.

Written by Lani Shadduck
HULIQ.com