Great News For Underwater Homeowners Looking to Break Free.

It used to be that, if you were an underwater homeowner who had fallen on hard times, and who had to do a short sale, the forgiven debt would be counted as income on your tax return. Think about that — you have $400,000 in debt against your home and, after the downturn, it’s only worth $250,000 when you are forced to sell it or have your lender foreclose. Then, at the end of the year, you owe income taxes on $150,000 that you didn’t earn in the first place. It didn’t make sense.

In 2007, the Bush Administration did something about this problem and signed into law the Mortgage Forgiveness Debt Relief Act. This allowed distressed homeowners to get out of the taxes that would have been due. The act was originally good only for three years, but was extended through the end of 2012 and extended once more through the end of 2013.

What was to happen at the end of this year was a complete mystery. To make things more even complicated, the State of California never extended its own exemption past the end of 2012. That meant that, if you did a short sale in 2013, you may not owe Federal taxes but you could still owe State taxes! Something needed to be done to permanently assist struggling homeowners.

That leads us to November 15, 2013 when Barbara Boxer released a September 2013 letter she received from the IRS. This letter gives a new opinion on how short sales should be handled. In short, most individuals who have to do a short sale won’t owe income taxes so long as their property is considered “residential” (four units or less per parcel) and they haven’t done anything fraudulent. Now, just last week, the Franchise Tax Board has issued this letter stating they would follow the same guidelines put forward by the IRS. Seemingly, we now have a permanent solution for how short sales will be handled.