Distressed homeowners no longer need to pay California state income tax on debts forgiven in a short sale, foreclosure, or mortgage loan modification. Introduced into law yesterday, Senate Bill 401 generally aligns California’s tax treatment of mortgage debt relief revenue with federal legislation. Pertaining to debt forgiven on a loan secured by a “qualified principal residence,” individuals will now be exempt from both federal and state income tax penalties. The current federal exemption is for indebtedness up to $2 million, whereas the California State Senete Bill 401 exemption is for indebtedness up to $800,000 and forgiven debt up to $500,000.

“Qualified primary residence” indebtedness is defined as debt incurred in purchasing, developing, or substantially enhancing a principal residence. It includes both first and second trust deeds. Additionally, it includes refinance loans to the extent the monies were used to payoff a previous mortgage loan that would have qualified.

The tax breaks affect financial obligations discharged from 2009 through 2012. Californians who have already filed their 2009 tax returns may claim their exemption by filing a Form 540X amendment.

Taxpayers who do not qualify for the aforementioned exemptions (e.g., second home or rental property) may 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 degree their current liabilities exceed current assets.

To learn more with regards to mortgage loan 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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Tags: debt relief, senete bill 401, tax relief

This entry was posted on Wednesday, April 14th, 2010 at 4:20 pm and is filed under mortgage. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.