California may tax debt forgiven in short sales as income

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Californians who were hoping that the state wouldn’t count loan debt forgiven in a short sale as income could be in for a rude surprise at tax time, as the fate of a bill to reinstate the tax break is tied to another bill that’s going nowhere.

There’s no opposition to SB 30, which would save homeowners who engaged a short sale or had debt forgiven in a deed-in-lieu of foreclosure about $50 million in taxes, the Sacramento Bee reports.

But the bill contains a “poison pill” that prevents it from taking effect unless the legislature passes SB 391, a more controversial bill that’s opposed by the California Association of Realtors and other real estate industry groups.

SB 391, the California Homes and Jobs Act of 2013, would impose a $75 fee to record real estate documents that are not connected with the transfer of property and already subject to a documentary transfer tax. That would raise about $300 million to $720 million a year for the development, acquisition, rehabilitation and preservation of homes affordable to low- and moderate-income households. The bill is aimed at replacing about $1 billion a year in property tax revenues that redevelopment agencies formerly provided to affordable housing funds.

Although SB 391 was approved 27-0 by the state Senate, it’s not going anywhere in the Assembly, because it requires a two-thirds vote that Democrats can’t muster.

So while everyone agrees that homeowners shouldn’t be penalized at tax time for having participated in a short sale or deed-in-lieu of foreclosure, it’s looking like the battle over recording fees means that’s what will happen when it’s time for Californians to pay their 2013 taxes.

The poison pill in SB 30, CAR says, was inserted into the bill to “punish homeowners and Realtors” for opposing the $75 recording tax.

The IRS won’t ding those former homeowners on their federal taxes. The Mortgage Forgiveness Debt Relief Act of 2007, which was scheduled to expire on Dec. 31, 2012, has been extended through the end of 2013.

When filing their federal tax returns, homeowners who experience a debt reduction through mortgage principal forgiveness or a short sale of their principal residence during 2013 may exclude up to $2 million of forgiven debt from their taxable income. Source: sacbee.com.