1099 Tax Implications After a Short Sale, Favorable Laws for California Homeowners in 2014- Aliso Viejo Real Estate

I do a lot of Short Sales, and every client in Aliso Viejo Real Estate is always worried about paying taxes, when they don’t have money to make a mortgage payment. I had to write something to clears some things up.

Here are the Short Sale related laws you should know about as a homeowner in 2014. Please seek the advice of a real estate attorney and a tax professional on how these laws apply to your specific situation. The good news in 2014 is that the California Franchise Tax Board has clarified that California families who have lost their residential home in a short sale are not subject to California state income tax liability on debt forgiveness “phantom income” will never be taxed if received a short sale, on residential home (1-4 units) with a non-recourse, purchase money loan. As long as Lender gives you an “Approval Letter” on the Short Sale. That is, the lender cannot pursue you personally in case of default. Please read the IRS letter to Senator Boxer clarifying whether a California homeowner would have taxable cancellation of indebtedness income on a lender approved short sale that qualifies under section 580e of the California Code of Civil Procedure (CCP).

Most California homeowners can now avoid foreclosure or bankruptcy and complete a short sale instead in 2014, without incurring California state tax. Also, even as the Mortgage Debt Relief Forgiveness Act’s expiration, there may not be a taxable event as a result of short sale with a loss, due to the IRS recognizing that the debt written off in a short sale does not constitute recourse debt under California law (580e), and thus does not create so-called “cancellation of debt” income to the underwater California home seller for federal income tax purposes. This means that you may be able to short sale your residential home in California in 2014 and not incur both state and federal income tax for completing a short sale. Please be sure to consult your tax advisor and legal professional on how these laws affect your specific situation. This law works for both primary residents and rental homes under 4 units. Also be sure to read below on “Is cancellation of debt always taxable?” You may also visit the IRS website here for more information on the Mortgage Debt Relief Forgiveness Act and Debt Cancellation.


According to the IRS, “Cancellation of Debt income is not always taxable.” The most common situations when cancellation of debt income is not taxable involve the following situations as shown below.

1.Qualified principal residence indebtedness: 
This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.

Debts discharged through bankruptcy are not considered taxable income.

If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.

4.Certain farm debts: 
If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.

5.Non-recourse loans: 
A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.”


Did you know that our short sale agent specialist has earned the nationally recognized Short Sales and Foreclosure Resource certification. The National Association of REALTORS® offers the SFR® certification to REALTORS® who want to help both buyers and sellers navigate these complicated transactions, as demand for agents with short sales expertise grows. Please contact Integrated Realty Group, for a confidential and free consultation.