Short Sale Laws Benefitting Southern California Luxury Home Sellers

Struggling owners of Southern California luxury homes may discover current California short-sale laws to give them an edge. Taxes are of primary concern for many of these homeowners. California law is different from US law on this topic.

California home sellers using Short Sales can avoid California state income tax liability if a series of conditions are met. In California law requires:

The property must be in California
It must be a primary residence
The property includes only 1 to 4 units
The loan must be non-resource
It must be a purchase money loan

The IRS does not always consider income stemming from Cancellation of Debt as taxable. The Mortgage Debt Relief Forgiveness Act once took care of that problem (2007-2013) and now it is the Homeowners Debt Relief Extension Act of 2014. Debts owed to someone else that are cancelled or forgiven may be taxable.

Homeowners Debt Relief Extension Act of 2014

A summary of the Homeowners Debt Relief Extension Act of 2014 states “amends the Internal Revenue Code to: (1) extend through 2015 the exclusion from gross income of imputed income from the discharge of indebtedness with respect to a principal residence; and (2) exclude from the definition of ‘domestic production gross receipts’ for purposes of the tax deduction for income attributable to domestic production activities.”

Situations that may allow exceptions to the tax burden, include:

Qualified principal residence indebtedness
Bankruptcy
Insolvency
Certain farm debts
Non-recourse loans (where the bank takes back the property and does not sue the owner)

By definition, a Short Sale means that a lender reduces the amount of the balance on a home loan. Here is an example of how a financially distressed Southern California homeowner could use the Homeowners Debt Relief Extension Act. If a Southern California home loan is for $2 million, the lender may agree to take $1.7 million for the home. Consequently, the borrower is given $300,000. The homeowner will not likely have to pay federal income taxes on that money.

Please refer to your CPA, tax accountant, and attorney to access the pros and cons of short sales in your specific situation.