Short sale ex-homeowners get an unpleasant surprise at tax time

[Liberal_in_LA]

Short sale tax shortchanges ex-homeowners
Carolyn Said, Chronicle Staff Writer

Monday, March 15, 2010

Tara Blackwell and her husband sold their Fairfield house in December for about half of its original $825,000 price as a short sale, in which the bank agrees to accept less than is owed on the mortgage.

The couple and their two children moved in with Blackwell's parents and thought the situation was behind them. Then it came time to pay their 2009 taxes.

To their dismay, they discovered that California would count the $412,000 difference between their original price and the sale price as part of their income, resulting in a hefty state income tax bill.

"We lost our down payment of $70,000, we lost our home and now California wants $38,000 (in extra taxes) from us," Tara Blackwell said. "It's like kicking you when you're down."

California legislators last week passed a bill that would fix the situation. It mirrors a federal law that excludes "forgiven debt" on a principal residence from being considered taxable income. It covers short sales, foreclosures, deeds in lieu of foreclosure and loan modifications that reduce the principal due.

However, Gov. Arnold Schwarzenegger, who has until March 23 to sign the bill, indicated that he is likely to veto it based on an unrelated provision regarding tax fraud.


Read more: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/03/15/MNO21CEDUK.DTL&tsp=1#ixzz0iH4zjYU8

[FarCenter]

1. Not charging taxes on forgiven debt is a subsidy of the improvident

Let them pay up.

[Missy Vixen]

6. They haven't suffered enough yet, have they?

Never should have bought a home in the first place.

:eyes:
:sarcasm:

The compassion of some here is simply overwhelming.

[FarCenter]

16. An $825K house in Farifield, CA??? They were living large while it lasted.

Check out prices in the area on Zillow. Most houses in the 200K range. They are probably Republicans.

From wiki re Fairfield, CA --

The median income for a household in the city is $49,151, and the median income for a family is $52,503. Males have a median income of $35,544 versus $27,616 for females. The per capita income for the city is $18,617. 13.1% of the population and 8.9% of families are below the poverty line. Out of the total population, 14.1% of those under the age of 18 and 7.2% of those 65 and older are living below the poverty line.

[Missy Vixen]

17. I also seem to remember shacks in Southern California

going for three quarters of a million dollars a few years back.

Then again, don't let me interrupt the glee so many DU'ers feel over anyone (in their opinion) who makes "too much money", lives in a larger house that's deemed more than the family needs, granite countertops, stainless steel appliances, a flat-screen television, getting their "comeuppance".

It's fun to celebrate other people's pain, isn't it?

:woohoo:

[FarCenter]

20. These are folks that thought they could afford $50K / year for housing

750 K mortgage at 5% is 37.5K / year. Add a couple thousand for payment of principle, add in property taxes, homeowners insurance and utilities and you are over $50 K/year for housing.


Not bad for a first house -- quite the "starter home".

[Missy Vixen]

22. I notice you never addressed my comment

There were 900 square foot ranch homes selling in Southern California before the bubble popped for three quarters of a million dollars, typically to those who worked in Silicon Valley and needed to own ANYTHING for tax purposes. I clearly remember multiple stories about this phenomenon on the national news.

Of course, it's much more fun to mock them now. After all, those who can't wait to post on these threads really enjoy the suffering of other people. If you think booting a family out of their home (and displacing children in the process) is just ducky because they're Republicans, I feel sorry for you.

[Bluebear]

18. 'They are probably Republicans.' - oh, OK, then it's alright to stick it to them. Whatever.

[anigbrowl]

21. Only if they get to keep the proceeds of said debt

Say I loan you $10,000 to buy a car. After a year you fall on hard times, and though you still owe me $5,000 I let it go and you keep the car. In that case, you'd be right. But if I repossess the car in lieu of the debt, you are not better off. You already paid for the use of the car while you had it, and gave it up when you were unable to do so, so your net gain is $0.

[yodoobo]

2. That's why bankruptcty has traditionally been a better option

as short sales or settlements result in a tax bill whereas Bankruptcy does not.

Obama fixed this with Federal taxes, however many states still have this provision.

[stopbush]

8. Actually, bush fixed this in 2007. Obama simply extended the program.

[Not Me]

9. As I understand it, the IRS extension is only until 2012

and then they want their piece too.

[sui generis]

3. more likely because the state was counting on that income

that's the real reason for that veto promise.

I agree the debt should be forgiven, but for this reason:

The bank gets a significant portion of their money immediately, and not in thirty years. The tax penalty is on the amount as paid out over thirty years, assuming that person had 30 years of use of the property. So as a tax on the value of the loss portion, it's inappropriate to assess a one time "income" when that "income" would typically be "spent" over some number of years of ownership.

The whole 1098 process needs to be revisited as far as I'm concerned. If somebody is in financial trouble and they get a lot of the debt forgiven WITHOUT seeking bankruptcy, they end up in permadebt to the IRS the following year, a situation which bankruptcy almost never significantly alleviates.

[Statistical]

5. I half agree. The debt should be ammortized over multiple years.

So rather than taking a $32K hit they should pay $3K a year for a decade.

[Missy Vixen]

4. This makes the new Obama administration program re: "cash for short sales"

even more interesting.

In other words, those in that program are going to get hammered at tax time, and it's being presented as an alternative to the overwhelming failure of Making Home Affordable.

:eyes:

[tammywammy]

11. It just depends on what state

This sounds like the problem is California's state income tax, not the federal income tax. California's so cash strapped I can see Arnold vetoing and legislation that reduces someone's tax bill.

Makes me glad I'm in a state without an income tax.

[TexasObserver]

7. Taxing debt forgiveness on distressed properties unforgivable.

It's a ridiculous concept - taxing forgiven debt on the theory it is income to the debtor. It usually is not, and should not be treated as such.

[marybourg]

14. If it were routinely not taxed how long do you think it would take

before people figured out that it was a great way to pass money on to someone tax free(children business associates, politicians), structure it as a legitimate loan, then forgive it. In fact, this is exactly what was happening before the tax code was amended to make debt forgiveness taxable

[TexasObserver]

15. Yes, I'm familiar with the IRC and its history.

Did I not say sales of distressed properties?

Of course a blanket approval of debt forgiveness would allow transfers of wealth among private parties that could deprive the Service of its cut of gain that hasn't been processed through the tax mill. I've never suggested that.

I stand my prior post as accurate. As I clearly stated, depressed sales should not result in taxation for the "gain." And most debt forgiveness - certainly that occurring in a declining economy - does not result in a real gain to the debtor.

[Edweird]

10. That's why it's better just to walk away. Bulldoze it. Dismantle it and sell it as scrap.

Rent it out as set for music videos. (One of my friends did something like that)
Turn it into a paintball course. (Don't forget waivers)


The IRS has guns and can put you in prison.
The bank cannot.

The IRS scares me.
Bankers do not.

Fuck 'em.

[Oregone]

12. Thats not income. Thats the bank's loss from a shoddy investment

Strange the way these rules exist

[louis-t]

13. You're right. It's always about what "the investors" want.

Every time I've done a short sale, we have to listen to what the investors want. Hey, they made bad investments, why am I being punished. They want to cut my commission, take 6 months to process, and they want the buyer to pay more for a short sale than for a bank foreclosure. And saying the homeowner "benefited" is not the same as "income".

[Xithras]

19. There is a provision in California law that neutralizes this a bit.

Shortsaled a rental in Modesto California last year after I lost my primary job and basically went from Upper Middle Class to "just barely skating by" with an adjunct teaching position.

While California does count Cancellation of Debt as income, it also has an INSOLVENCY exclusion. If your total debt exceeds the total value of your assets, CoD income is excluded from taxation up to the amount of your insolvency.

In other words, if you have $100,000 in debt (including mortgage debt), no assets, and have a $150,000 CoD, you will only owe taxes on $50,000 worth of the debt.

I personally had $160,000 in debt forgiven and my net worth at the time was about -$200,000 (because the value of my primary residence is far lower than the current mortgage owed). I didn't have to pay a penny in taxes on any of it because my insolvency exceeded my forgiven debt amount.

The thinking here is simple. They're not going to tax you on forgiven debt if you're already upside-down, but they're not going to let you increase your net worth without taxing the difference.