No More State Tax on Forgiven Debt

NO MORE STATE TAX ON FORGIVEN DEBT

Distressed homeowners no longer have to pay California state income tax on debt forgiven in a short sale, foreclosure, or loan modification.  Enacted into law yesterday, Senate Bill 401 generally aligns California’s tax treatment of mortgage debt relief income with federal law.  For debt forgiven on a loan secured by a “qualified principal residence,” borrowers will now be exempt from both federal and state income tax consequences.  The existing federal exemption is for indebtedness up to $2 million, whereas the new California exemption is for indebtedness up to $800,000 and forgiven debt up to $500,000.

“Qualified principal residence” indebtedness is defined as debt incurred in acquiring, constructing, or substantially improving a principal residence.  It includes both first and second trust deeds.  It also includes a refinance loan to the extent the funds were used to payoff a previous loan that would have qualified.

The tax breaks apply to debts discharged from 2009 through 2012.  Californians who have already filed their 2009 tax returns may claim the exemption by filing a Form 540X amendment.

Taxpayers who do not qualify for the above exemptions (e.g., second home or rental property) may nevertheless be exempt under other provisions.  Most notably, taxpayers who are bankrupt are exempt from debt relief income tax.  Also, taxpayers who are insolvent are exempt from debt relief income tax to the extent their current liabilities exceed current assets.

For more information about mortgage forgiveness tax consequences, go to California Franchise Tax Board’s Mortgage Forgiveness Debt Relief Extended webpage and the Internal Revenue Service’s Mortgage Forgiveness Debt Relief Act and Debt Cancellation webpage.  The full text of Senate Bill 401 is available at www.leginfo.ca.gov.

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Market News in Real Estate

Governor signs home tax credit bill

Governor Schwarzenegger today signed AB 183 providing $200 million for home buyer tax credits. The bill allocates $100 million for qualified first-time home buyers who purchase existing homes and $100 million for purchasers of new, or previously unoccupied, homes.

Eligible taxpayers who close escrow on qualified principal residences between May 1, 2010 and December, 31, 2010, or who close escrow on a qualified principal residence on and after December 31, 2010 and before August 1, 2011, pursuant to an enforceable contract executed on or before December 31, 2010, will be able to take the allowed tax credit.

This credit is equal to the lesser of 5 percent of the purchase price or $10,000, taken in equal installments over three consecutive years. Under the bill, purchasers will be required to live in the home as their principal residence for at least two years or forfeit the credit (i.e. repay it to the state). Buyers also must be at least 18 years old and be unrelated to the seller. First-time buyers are defined as those who have not owned a home in the past three years.

To learn more about the California Home Buyer Tax Credit, click here

The Los Angeles Times Reports

IRS tells homeowners how to get tax relief if a lender forgives part of their debt

Generally, the Internal Revenue Service (IRS) treats debt forgiveness by a creditor as taxable income. However, under federal legislation that took effect in 2007, certain home mortgage debt cancellations—such as loan modifications, short sales, or foreclosures—may be exempted from federal taxes. Other exemptions are also available.

MAKING SENSE OF THE STORY FOR CONSUMERS

• Homeowners considering a loan modification, short sale, or foreclosure should note that the federal tax exclusion under the Mortgage Forgiveness Debt Relief Act of 2007 only applies to mortgage balances on a qualified principal residence and not on second homes, rental real estate, or business properties.

• The maximum amount of forgiven debt eligible under the 2007 law is $2 million for married taxpayers filing jointly and $1 million for single taxpayers.

• The debt reduction only can be for loan amounts used to buy, build, or substantially improve a principal residence, including refinance loans as long as an increase in the total mortgage debt if any is attributable to renovations and capital improvements of the house. However, if refinance proceeds were used for other personal purposes, such as paying off credit card bills, purchasing cars, or investing in stocks, then the mortgage debt attributable to those expenditures is not eligible for tax exclusion under the 2007 law.

• California homeowners who sold their house in a short sale or were foreclosed upon in 2009 still may have to pay state taxes on forgiven mortgage debt. The California legislature did not extend the tax exemption for mortgage debt forgiveness for state taxes. However, lawmakers are working on a bill that would provide the same tax relief on state taxes as the federal government currently offers.

To read the full story, please click here:

Bloomberg Reports

Housing real-estate recovery signaled as Fed unwinds

The U.S. housing market is poised to withstand the removal of government and Federal Reserve stimulus programs and rebound later in the year, contributing to annual economic growth for the first time since 2006.

To read the full story, please click here:

The Sacramento Bee Reports

Option ARM mortgages still pose a risk Inside the fallout from risky housing boom loans in Sacramento, one particularly notorious brand of mortgage, the option ARM, still looms as big potential trouble.

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The Los Angeles Times Reports

More homeowners are opting for “strategic defaults”
Underwater on their mortgages and angry at banks, more borrowers are choosing to hand over the keys, even if they can afford the payments.

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The Wall Street Journal Reports

Supply of foreclosed homes on the rise again
The supply of foreclosed homes that banks need to sell is rising again, signaling further downward pressure on home prices in some parts of the U.S.

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The Mercury News Reports

Mortgages: Congress debates how to revive home-loan market
Lawmakers are starting to wrestle with how to replace Fannie Mae and Freddie Mac, the mortgage giants that nearly collapsed at the start of the financial meltdown.

To read the full story, please click here:

The Press Enterprise Reports

Flip squads take on foreclosed houses, try to turn profits
Each weekday morning, a troupe of opportunists who hope they have the Midas touch unfold camping chairs in front of the old Riverside County courthouse.

To read the full story, please click here:

The New York Times Reports

When not to pay down a mortgage
The Federal Reserve has reaffirmed its intention to stop buying mortgage-backed securities, signaling the likelihood that the mortgage rates you can get today are as good as they’re going to be for a long time. Once the Fed stops buying, after all, rates are likely to go up.

To read the full story, please click here:

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Home Buyer Tax Credit Update

$18,000 IN COMBINED HOMEBUYER TAX CREDITS FOR A LIMITED TIME

Californians have a brief window of opportunity to receive up to $18,000 in combined federal and state homebuyer tax credits.  To take advantage of both tax credits, a first-time homebuyer must enter into a purchase contract for a principal residence before May 1, 2010, and close escrow between May 1, 2010 and June 30, 2010, inclusive.  Buyers who are not first-time homebuyers may use the same time frames to receive up to $16,500 in combined tax credits if they are long-time residents of their existing homes as permitted under federal law, and they purchase properties that have never been previously occupied as provided under California law.

Under the federal law slated to soon expire, a first-time homebuyer may receive up to $8,000 in tax credits, and a long-time resident may receive up to $6,500, for certain purchase contracts entered into by April 30, 2010 that close escrow by June 30, 2010.  Additionally, under a newly enacted California law, a homebuyer may receive up to $10,000 in tax credits as a first-time homebuyer or buyer of a property that has never been occupied.  The new California law applies to certain purchases that close escrow on or after May 1, 2010 (see Cal. Rev. & Tax Code section 17059.1(a)(4)).  California law generally allows buyers of never-occupied properties to reserve their credits before closing escrow, but buyers seeking to combine the federal and state tax credits will not be able to satisfy the timing requirements for such reservations (see Cal. Rev. & Tax Code section 17059.1(c)(1)(A)).  Other terms and restrictions apply to both tax credits.

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