It took a lot longer than expected, but California homeowners who received mortgage debt relief last year won’t be on the hook for state taxes tied to so-called phantom income.
California Assembly Bill 1393, introduced by Assembly member Henry T. Perea (D-Fresno), extends tax relief on the forgiveness of mortgage debt by conforming California law to federal law.
The California State Senate approved the bill on June 30th, passing it with an overwhelming 33-0 vote, which was later followed by a 68-0 vote by the Assembly last Thursday.
Thanks to this bill, which should be signed into law by Governor Jerry Brown shortly, California homeowners who had certain debt canceled or forgiven last year will be able to amend their taxes and get refunds.
New Bill Will Provide State Relief to Align with Existing Federal Law
Early last year, the Mortgage Forgiveness Debt Relief Act of 2007 was given a one-year extension, meaning those who were foreclosed on or sold short didn’t have to worry about federal taxes on gains they never actually realized.
Typically, mortgage debt that is forgiven by a bank or lender must be included as ordinary income on your tax return, but the Mortgage Forgiveness Debt Relief Act allows borrowers to exclude certain canceled debt tied to a principal residence.
Additionally, debt reduced through mortgage restructuring such as a loan modification (principal reduction) also qualifies for tax relief.
But while federal taxes may have been avoided last year, some California homeowners were still subjected to state taxes in certain cases.
It’s unclear how many homeowners actually got taxed thanks to anti-deficiency laws already in place that protected many of those who sold their homes for less than what they were worth, but the state estimates taxpayers will save roughly $39 million.
The bill also protects homeowners from penalties regardless of whether they reported the discharged debt on their 2013 tax return.
Unfortunately, this bill will only cover transactions that occurred in 2013, meaning uncertainty still looms for mortgage debt forgiven this year. Another extension will likely be necessary…
The same goes for federal tax relief, which also hangs in the balance as politicians work on a tax extenders package.
Of course, much of the mortgage relief has already been doled out, with short sales, foreclosures, and loan mods all dropping in numbers considerably as home prices continue to rise.
Still, the passage of this bill should give homeowners a lot more confidence to move forward with such an action without fear of being on the hook for state taxes.
However, even if the discharged debt isn’t taxable, a taxpayer may still have to deal with taxes if there was a gain from the sale or foreclosure of the property.
As always, be sure to consult with a lawyer, CPA, and/or tax preparer to ensure you understand the implications of this bill and other related laws. It’s certainly complicated, so enlisting a professional is probably not a bad idea.