California Enacts Mortgage Forgiveness Debt Relief

by Lee Reams in Breaking News

A new California state law allows taxpayers to immediately exclude from their income the amount of mortgage debt on their home loan that has been forgiven by their lender. The law is retroactive to January 1, 2009 and generally brings California statutes into conformity with current federal law but with a lower maximum exclusion amount.

Where Federal law allows $2 million ($1 million for married taxpayers filing separately), the new California law only allows $500,000 ($250,000 for a married taxpayer or a registered domestic partner filing separately).  The good news is that this is sufficient for most homeowners to exclude all or most of the debt relief income from their California tax return. 

This new law applies to debt forgiveness in 2009 through 2012 resulting from a foreclosure, “short sale,” or loan modification of a taxpayer’s qualified personal residence.  This new law does not apply to a taxpayer’s second home, business or investment property. 

California has always conformed to the Federal debt relief income exclusion for insolvent taxpayers.   Under the insolvency provision, taxpayers are able to exclude debt relief to the extent that they are insolvent (to the extent liabilities exceed assets).  Taxpayers who were unable to utilize the insolvency exclusion or where the insolvency exclusion was not enough to exclude all of the debt relief income may also benefit from the new law.

According to FTB estimates, approximately 100,000 people may benefit from mortgage debt relief for tax years 2009-2012. For more information, visit the California Franchise Tax Board’s website.

Qualifying taxpayers who have already filed their 2009 tax returns should file Form 540X, Amended Individual Income Tax Return to subtract the amount of debt relief from income. To expedite processing, write “Mortgage Debt Relief” in red across the top of the amended tax return. Taxpayers must attach a copy of their federal return, including Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), with their state tax return.

Completing the necessary paperwork can be a complicated task.  If you need assistance, please contact one of our professionals.