The Internal Revenue Service recently clarified that California homeowners would not be liable for federal income tax on debt forgiven in a short sale, even after the expiration of the federal Mortgage Forgiveness Debt Relief Act of 2007 at the end of this year.

Now the California Franchise Tax Board has issued a similar clarification letting homeowners off the hook for state income taxes on “phantom income” from debt written off in a short sale, a move that will affect tens of thousands of distressed home sellers in the Golden State, according to the California Association of Realtors.

“We are pleased with the recent clarifications issued by the IRS and the California Franchise Tax Board, which protect distressed homeowners from debt relief income tax associated with a short sale in California,” said CAR President Kevin Brown in a statement.

Distressed California homeowners, Brown said, “can now avoid foreclosure or bankruptcy and can opt for a short sale instead,” without incurring federal and state tax liability. Source: CAR

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