With the surging San Francisco and Bay Area real estate market, shorts sales and foreclosures have seen a steep decline. Even so, they still exist in San Francisco, San Mateo County as well as neighboring counties and cities.
Thanks to California Senator Barbara Boxer who pushed this issue with the IRS and got this letter as clarification about the Mortgage Debt Forgiveness Act.
“The IRS has clarified in a letter that California’s troubled homeowners who sell their homes in a short sale are not subject to federal income tax liability on “phantom income” they never received.”
Homeowners in California involved in short sales have been concerned with “phantom income” which refers to the amount of debt that is forgiven when a lender is willing to accept less than the full amount owed (as in a short sale). If you owed $500,000 on your mortgage, and the lender allowed a short sale for $450,000, you would have “received” $50,000 in phantom income.
In 2012, Congress extended the Mortgage Forgiveness Debt Relief Act. The California version expired at the end of 2012. The Federal provision expired at the end of 2013. This year instead of waiting for Congress to pass (or not) the Mortgage Forgiveness Debt Relief Act, the IRS and the Franchise Tax Board (California’s version of the IRS) eliminated the phantom income tax. In short, California short sellers of residential properties (1 – 4 units) will continue to be protected from taxation on the “phantom income” received in a short sale.
With so many issues nipping at the heels of still underwater homeowners at least the fact that Uncle Sam and his California cousin will not have their hands out at the end of any short sale transaction ready to collect phantom income will make things slightly easier for still distressed property owners.