Critical Alert: Taxability of California Short Sales

Critical Alert Regarding Taxability of California Short Sales! 
The IRS has recently issued a clarification letter to it’s September 19, 2013 letter to Senator Barbara Boxer concerning short sales and taxation of forgiven debt. The clarification essentially reverses their statement in the 2013 which read, “We believe that a homeowner’s obligation under the anti-deficiency provision of section 580e of the CCP would be a nonrecourse obligation to the extent that, for federal income tax purposes, the homeowner will not have cancellation of indebtedness income.” In simple terms, there would be no Cancelation of Debt Income on a short sale of a taxpayer’s principal residence. 
Here’s a link to the original letter. This the second paragraph on Page 2 that starts, “We believe …”
However, in the new April, 2014 letter, the IRS states their original analysis “overly broad”. The letter states that in order for a debt to be non-recourse at the time of the short sale, the original debt must be used to purchase or build a 1-4 principal residence or a refinance of such debt. As such, a cash out refinance or a loan used to substantially improve the taxpayer’s principal residence may now be treated as cancellation of debt income. The IRS also clarified that an investor’s short sale debt will be characterized by the nature of the debt at inception. If it was recourse debt (non principal residence purchase) originally, it will remain recourse debt at the time of the short sale, and thus subject to cancelation of debt income. 
Here’s a link to the new letter.
Of course, as you probably guessed, the new IRS is vague and leaves many questions unanswered. As such, Senator Boxer’s sent request for further clarification of several issues and asked for the IRS’s position on homeowners who completed a short sale while relying on the September, 2013 letter. 
Here’s a link to Senator Boxer’s letter.
In our capacity as REALTORS®, Todd and I advise our clients to consult with qualified tax and legal professionals regarding this very important development.


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Todd Moeller

Seven Gables Real Estate

[email protected]