Latest on Short Sale Mortgage Forgiveness Tax Relief for Sellers in California

From the California Association of Realtors and IRS:
NO FEDERAL DEBT RELIEF INCOME TAX FOR SHORT SALES

A short sale in California is generally not subject to federal income tax for mortgage debt forgiveness, according to a recent letter from the Internal Revenue Service (IRS).... We are also hopeful that we can promptly obtain similar guidance regarding state income tax for mortgage debt relief income from the California Franchise Tax Board (FTB), which has been awaiting this IRS letter.

Given that a homeowner in California generally cannot be held personally liable for a short sale deficiency (see below), the IRS stated in its letter that it would consider the mortgage loan as a nonrecourse obligation that is not subject to federal debt relief income tax.  The amount of indebtedness, however, must be reported as the amount realized for capital gains purposes. Of course, a principal residence is generally excluded from capital gains tax up to $250,000 for single taxpayers and $500,000 for married couples filing joint returns (under 26 U.S.C. § 121).

As background, California law generally protects a borrower from owing a deficiency after a short sale of a residential property with one-to-four units, including both first and junior trust deeds (Cal. Code of Civ. Proc. section 580e). Exceptions include fraud, waste, cross-collateralized loan, and a borrower that is a corporation, LLC, or limited partnership. For more information, see C.A.R.’s legal article on Short Sale Deficiencies.

Although short sale sellers of a qualified principal residence are currently protected against federal debt relief income tax under the Mortgage Forgiveness Debt Relief Act of 2007, that federal law is set to expire on December 31, 2013, whereas the tax exemption set forth in the IRS letter has no expiration date. Similar protection to the federal Mortgage Forgiveness Debt Relief Act for state income tax under California law has already expired on December 31, 2012. However, other exemptions from federal and state taxation of debt relief income are available, such as for bankruptcies and insolvencies. REALTORS® should encourage their clients to seek the advice of a tax professional regarding the tax consequences of a short sale.

It's Back! Misinterpretations of the 3.8% Medicare Tax Persist

For all its problems, Obamacare does not impose the real estate transfer tax that the recurring viral email you may have seen says it does.  Here's a key line from the erroneous email:


"If you sell a $400,000 home, there will be a $15,200 tax." 


Fortunately, this simply isn't true. Yes, there is a new 3.8% tax, effective in 2013 unless Obamacare is overturned.  But it would apply to the gain on a sale, not the sales price!  And only to the portion of that gain in excess of the $250,000 (single) / $500,000 (married) gain exclusions!  And only for taxpayers whose adjusted gross income exceeds certain thresholds.  


For more details, here are links to two publications from the National Association of Realtors:


The 3.8 Tax: NAR's Q&A
The 3.8 Tax: NAR's Brochure


The last thing our struggling economy needs is more taxes, but misinformation is not the way to get them overturned. 


-David

David Quoted in AP Mobile News story - Realtors object to proposed business tax

Your blogger weighs in on a proposed tax upon real estate agents in Manhattan Beach in this article picked up today by the AP:

http://m.apnews.com/ap/db_8545/contentdetail.htm?contentguid=NDCx4K55

A couple of broader points were missed in the article, namely:

• Doing anything to further discourage the players in an industry whose work creates jobs for many others (contractors, repairmen, inspectors, appraisers, home improvement stores, appliance and entertainment vendors, schoolteachers, etc.) is narrowminded at best
• Property taxes are the largest single component of the city's revenues. The City's property tax revenues go up every time a home is sold, resulting in a new assessed value under Prop. 13.  The best agents aren't just order-takers, they prompt real estate transactions.  .  I'll save you the computatoins but the increased property tax annuity received by the City after a home sale is much greater than the tax in the short-sighted city staff proposal
• City staff would love to double-tax the real estate industry, but probably don't expect to get away with it.  So there's a proposed credit to brokers for commissoins taxed at the agent level. So why would City staff care who pays the tax?  Because assessing the tax at the agent level is a clever way of sidestapping the cap which comes into play at the broker level but never would at the agent level
• City staff mailed out letters announcing the new tax without first obtaining the permission, let alone the direction, of the City Council. This opaque approach to running city management was a trademark of our now deposed City Manager's administration.  It will be nice to see a few more chages in City staff once a capable new City Manager institutes policies of transparency to all and deferral to the Council which has long been absent. - David

1033 (not 1031) Exchange Considerations upon Involuntary Conversion of Property

Sales of Business Property (Also Involuntary Conversions and and Recapture Amounts Under Sections 179 and 280F(b)(2)), IRS Tax Form 4797, 2006

After spending the better part of a day looking into the matter for a current client conducting a large 1033 exchange of real property, my considered but inexpert opinion is that there is little if any specialized expertise required for an escrow company to carry out its role in a 1033 exchange (meaning an exchange to defer taxation upon the involuntary conversion of an investment property).