Project Description

In a letter from the California Franchise Tax Board (FTB) to the State Board of Equalization, the FTB indicated that a California taxpayer would not have cancellation of indebtedness where the taxpayer was involved in a short sale pursuant to Cal. Code Civ. Pro. §580e. However, the taxpayer may have gain on the short sale of the residence. Where the loan is non-recourse, the borrower will be treated as having sold the property for the amount of the outstanding debt or the fair market value of the property, whichever is greater. Therefore, the borrower may have gain to the extent the outstanding debt or fair market value exceeds the borrower’s basis in the property. Where the loan is recourse, meaning that the borrower may also be personally liable for the obligation and the borrower is relieved of all or a portion of the obligation, the borrower may have a taxable income in two respects. The borrower may have a gain on the short sale to the extent the fair market value of the property exceeds the borrower’s basis in the property sold, and the borrower may also have cancellation of indebtedness income equal to the forgiven amount of the loan. Cal. Code Civ. Pro. §580e(a)(2) provides that if a lender agrees to a short sale of property, the lender may not be entitled to a judgment for the outstanding debt that remains after the short sale of the property is completed. In effect, the short sale proceeds will satisfy the outstanding debt obligation and the borrower is no longer personally liable. In light of a recent IRS letter, in which the IRS found that an obligation involved in a sale pursuant to Cal. Code Civ. Pro. §580e would be treated as a nonrecourse obligation for federal income tax purposes, the FTB indicated that for California purposes, a homeowner would be treated as having been relieved of a nonrecourse obligation. The homeowner may have gain to the extent that the outstanding debt or the fair market value of the property, whichever is greater, exceeds their basis in the property sold. ( Letter from FTB to SBE: Short Sales and COI, 12/04/2013 .)

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