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Sacramento Short Sales Mortgage Debt Relief IRS Letter
Sacramento sellers who expect to close on a short sale in 2014 have a very good reason to send flowers to Sen. Barbara Boxer and, while they’re at it, maybe C.A.R. as well. I received the best news this morning, which I can’t wait to share with everyone because it’s about mortgage debt relief. Taxation on mortgage debt relief has been on the tongue of every single short sale seller I have talked to who might have to close escrow next year.
In a nutshell, we have no worries about federal taxation on mortgage debt relief resulting from most closed short sales in California from here on out. Other states, they probably have cause for concern, but not California. What makes California so special apart from our sunny weather, smog-hidden mountains and polluted oceans, and let’s not forget Cal Worthington? We’ve got California Civil Code 580e, resulting from the passing several years ago of SB 458.
Under ordinary circumstances, the federal tax code says if a person has had debt canceled, the amount that was forgiven is subject to taxation. However, in 2007, the Mortgage Debt Forgiveness Act passed that says taxation on canceled debt does not apply to a short sale, subject to certain criteria. Every year, the mortgage debt relief protection has expired and every year the federal government has extended it. This year, it’s not yet been extended because our lovely legislators continue to wrap in the mortgage debt relief extension with other legislation that won’t get passed even if they lined up every legislator against the wall, blindfolded them and threatened to shoot them all at will.
This political game has caused short sale sellers in Sacramento extraordinary grief and stress. Many of my sellers have called to say they don’t know what they will do if we can’t close their short sale by December 31st, 2013, when the federal mortgage debt relief protection expires.
However, the argument brought forth to the I.R.S. by Sen. Barbara Boxer, with C.A.R.’s assistance, is that sellers are released from personal liability in a short sale under California Civil Code 580e, and that makes short sales non-recourse, so why should a seller be subject to federal taxation on top of it? The I.R.S. agreed and issued a letter that said California short sales protected by our California Civil Code 580e are not subject to federal taxation for mortgage debt relief. This is huge!
C.A.R. and Sen. Barbara Boxer are working on a similar letter from the state of California, which is expected to follow suit.
California Short Sale Taxes vs. Personal Liability
A reader from my homebuying website on About.com asked me this morning if he could stop paying on a promissory note after his short sale closed. His short sale agent negotiated, he said, two purchase-money loans in 2010, in which he ended up paying the second lender $5,000, plus he handed over an additional $10,000 promissory note to a credit union. I suspect that the credit union loan was not a purchase-money mortgage because credit unions were not in the business of financing 80 / 20 combo loans. I’m betting that second loan was a hard-money loan. But that’s neither here nor there. The main problem for this guy seems to be that he negotiated a discounted payoff and promised to repay part of it, which he hopes to undo.
This is a pretty good example of short sale confusion. Not only do some people hope that once a law changes or goes into effect that it’s retroactive and can reach back into the past to change agreements or somehow alter things that were legal to do into being against the law — which ain’t gonna happen — but personal liability is often confused with taxation issues. Whether in California a seller has personal liability for a loan after a short sale is a separate issue from whether a seller is liable to pay taxes on that forgiven debt. Mortgage debt relief and whether banks can legally pursue a seller for a deficiency are not the same thing. They are two different things.
But wait, you might say, does this mean a bank might try to collect the balance due on a short sale at the same time the government goes after a seller for taxes on that balance due? Yes, that’s exactly what I am saying. It’s a double whammy.
Fortunately, SB 458, passed in California in July of 2011, added Section E to the California Civil Code 580. It basically says that short of mortgage fraud, in which case it can still pursue, if a seller does a short sale on 1 to 4 units, the bank can’t pursue; can’t go after the seller. But that’s for short sales that closed after July of 2011. It doesn’t matter if the loan was hard money or purchase money, whether the property was owner occupied or a rental, whether the loan was in first, second or third position. Can’t go after the seller. This is a good reason to avoid foreclosure and try to do a short sale. Especially if a seller has a hard-money loan because, legal experts say, foreclosure proceedings do not offer any protection for the seller against a hard-money loan.
But can the seller be taxed on a short sale? On the federal side, for 2013, the mortgage debt relief law has been extended to January 1, 2014. The California law regarding short sale taxes for 2012 has expired. State legislators are working on an extension. This is the part where the law after extension the last time was made retroactive. It took California lawmakers almost a year to pass the extension last go around. We were sweating. But then they made it retroactive. Will they do it again this year? We sure hope so. But this is a classic example of why a seller in Sacramento should get legal and tax advice before doing a short sale. Don’t rely on your Sacramento short sale agent to dispense legal and tax advice because we are not allowed to do it.
Why You Might Not Care About Mortgage Debt Relief
Many of my Sacramento short sale sellers are concerned about the mortgage debt relief extension, which is presently sitting at the U.S. Senate in limbo. Mortgage debt relief is the process of relieving a seller of having to pay taxes on forgiven / canceled debt. For example, if you sell a home for $100,000 and you owe $200,000, the bank is forgiving $100,000 of debt when it does a short sale or a foreclosure. Under regular IRS rules, you might be responsible for paying taxes on $100,000 of income that you did not get in your hot little hands. If you’re in a 30% tax bracket, that’s $30,000 you could owe the IRS.
At present, this relief from taxation expires at the end of this month, on December 31, 2012. There is a bill extending the relief through 2013. It stems from an original bill that was passed 5 years ago and has been extended ever since: the 2007 Mortgage Forgiveness Debt Relief Act. The big question is will it be extended again?
The bigger question should be what happens if it doesn’t? Are you affected? This is the question I would like every Sacramento area short sale seller to ask an accountant. Don’t go poking around online reading crap that may or may not be true — including this blog. I am not an accountant. I cannot give you tax advice. I am a Sacramento short sale agent. I sell homes all over a four-county area. Lots of them. More than 100 a year. But I don’t give tax advice.
Having said that, I will tell you that accountants have told me that California purchase money loans are not affected. They say it does not matter whether you close this year or next year or ten years from now, if you have a purchase money loan and you live in California, there are no taxes due on that canceled debt. Furthermore, mortgage debt relief is not a short sale exception. If you have to pay taxes for some reason on canceled debt, it applies to foreclosures as well as short sales. So, opting for foreclosure instead of doing a short sale is not going to save your butt. But don’t take it from me, ask your accountant.
Moreover, ask your accountant about insolvency exceptions. If you owe more than your assets are worth, you might be insolvent. Insolvency does not mean you are sleeping under a bridge and holding a sign saying something goofy like you will work for food when what you mean is you would like somebody to give you some money. It means your liabilities exceed your assets. Almost every short sale seller is in that boat. If you are insolvent, the government makes an exception for you.
So, before you get all excited over whether the mortgage debt relief will be extended, please, I beg of you, talk to an accountant. Doing a short sale is stressful enough without adding this little quirk to it. It might be totally unnecessary for you to stress over mortgage debt relief. Read this recent article by reporter Ken Harney in the Washington Post, after he interviewed this Sacramento short sale agent about mortgage debt relief.
