CPA Kevin Just explains Short Sales and Foreclosures and how it relates to your taxes

This Blog Post is written by CPA Kevin Just

About Kevin Just: CPA who has assisted the real estate industry for 32 years and currently manages Just, Gurr & Associates, voted best accounting firm in Silicon Valley in 2010 and 2011 in the Mercury News Readers’ Choice Awards.


Cancellation of Indebtedness Associated with Principal Residence

A taxpayer may realize income from cancellation of indebtedness (COD) on their principal residence either by foreclosure, deed-in-lieu or by short sale. How the income is reported depends on whether the mortgage debt is recourse or nonrecourse. If there is income, then there may be elections applicable to the transaction allowing the income to be excluded from taxation. If there is a loss on the transaction, the loss is a non-deductible personal loss.

First mortgages used to purchase the property are generally nonrecourse in California. Also in California, second or third mortgages are normally recourse as well as are refinanced first mortgages. To be certain, the mortgage document would need to be closely reviewed.

If your property is foreclosed, given to the bank or sold in a short sale, and your debt is nonrecourse, then the transaction is treated as a deemed sale. In the deemed sale, the balance of the nonrecourse loan is the sale price and your cost in the property is deducted from the sale price. If there is a loss, it is nondeductible. If there is a gain, the gain may be excludable due to the sale of principal residence exclusion rules.

If your property is subject to recourse debt, either a refinanced first mortgage or a second mortgage, there will be COD income. COD income is ordinary income. There are various exclusion provisions in federal and California tax law that the taxpayer can elect in order to avoid tax on this income. There are old tax provisions that can be used and then there are new ones that have been in the news recently. The old provisions allow exclusion of COD income if the taxpayer files for bankruptcy protection or if he is insolvent on the date of the COD event. The new provisions are targeted towards principal residences. Both federal and California law were revised to help homeowners after the recent financial collapse. Federal law allows unlimited COD income exclusion for income associated with qualified debt canceled between 2008 and 2013. California has similar rules, but there is a maximum that can be excluded of $500,000 on debt of no more than $800,000.

Debt forgiveness associated with property that is not a principal residence has some similarities, but many differences. Properties that are not a principal residence are not discussed here as it is a much more complex discussion.

Kevin Just
Just, Gurr & Associates CPAs


This information is of a general nature and is intended to highlight general tax matters. It should not be used as a substitute for specific tax advice. You should seek the guidance of a competent accountant and/or attorney in order to consider these issues within your special situation. Kevin Just can be reached at Just, Gurr & Associates, 1500 E. Hamilton Ave, Suite 200, Campbell, CA 95008; (408) 371-2200; or by e-mail at kjust@justgurr.com Visit our website at http://www.justgurr.com/