A Sale's Tax Consequences in California

A short sale offers relief for homeowners who have to sell their houses but owe more than they are worth. Via a short sale, homeowners receive consideration from lenders to forgive a portion of the mortgage loan debt. The amount of the forgiven debt is the gap between the short sale price and also the balance of the mortgage loan. When homeowners run a short sale, however they also must think about the tax consequences. California state law orders the consequences homeowners face when they run a short sale in this state.

Income Tax Consequences

Typically, California tax law requires homeowners to report debt forgiven during a short sale. This debt that was forgiven is known as earnings. The addition of this amount to a citizen’s other sources of earnings increases his tax liability. Thus, taxpayers can have to pay more in income taxation when they run a short sale even though they never actually had physical control over the debt that was forgiven. State tax legislation also forbids taxpayers from claiming deductions for losses caused by a short sale.

Income Tax Exclusion

In April 2010, California Gov. Arnold Schwarzenegger signed legislation dubbed the Conformity Act of 2010. This proved a sunset law in the country that provides homeowners with an exclusion from income taxation duties when a short sale ends in debt forgiveness. The legislation provides an exclusion from taxation for individuals who have received around $800,000 of forgiven debt. The full $800,000, however, is not excluded. Instead, the country excludes the first $500,000 of forgiven debt around $800,000. Individuals who have received debt forgiveness which is more than $800,000 won’t have any relief from taxation consequences. They have to report each of the forgiven debt as earnings. The legislation applies to state income taxation for 2009. Homeowners are required to report the forgiven debt on Form 540. If the exclusion is for previous tax years, taxpayers must file Form 540X. The new exclusion replaced one for tax years 2007 and 2008. It gives an exclusion of up to $250,000 for taxpayers that received around $800,000 of debt forgiveness.

Real Estate Tax Consequences

A short sale on a house has a few benefits for homeowners that are facing tax bills they can’t pay. If homeowners figure out how to sell their houses before the county tax collector can establish a tax lien for nonpayment of property taxation, a lien cannot be placed on the house as a means of securing the debt. This provides a considerable benefit for homeowners. Without the short sale, the homeowners would have been subject to the limiting consequences of a tax lien, which will prevent the homeowner out of selling the house before the lien is paidoff.

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