A new law signed by Governor Arnold Schwarzenegger on Monday will provide relief for some homeowners in distress. Senate Bill 401 eliminates the state tax on debt forgiven by banks in a short sale, loan modification or foreclosure.
Before the law was passed, homeowners were responsible to pay taxes on "phantom income" -- the difference between the original loan amount and the amount the property sold for in a short sale or foreclosure. That phantom income ruled also applied to the moneys forgiven in a loan modification.
The new state law brings California in line with federal tax rules. The federal government has long forgiven some types of forgiven debt on a primary residence.
The forgiveness only applies to loans used to purchase a primary residence. It will apply to some refinances, as long as the refinance was used to replace the original loan. It applies only to debt discharged from 2009 thru 2012.
Tax payers who do not qualify under the provisions of SB 401 may still be exempt from paying taxes on forgiven debt under other provisions. It is important to discuss the implications of a loan modification, short sale or foreclosure with your tax accountant and/or attorney.
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