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If You are Short Selling Your Los Angeles Home Will You Have to Pay Taxes on the Debt Forgiveness?

By
Real Estate Broker/Owner with Home Jane Realty BRE# 01439865

What is a short sale?Short Sale Target

If you are having a hard time paying your mortgage and owe more than the property is worth, then you may consider short selling your Los Angeles home.  What this means is that you would list the house at market price and work with prospective buyers until your come to an agreement.  Your listing agent would then approach the lender and work with them on an acceptance of the buyer’s offer.

This is a long and involved process during which you would have to prove hardship, and there is no guarantee the lender will agree to the sale, even though the alternative could be foreclosure.

Will there be a deficiency judgement on my Los Angeles short sale?

As of January 1, 2011 Civil Code section 580e was introduced which states that on residential one to four-unit buildings the first trust holder cannot get a deficiency judgement against the borrower, even if there was no specific waiving of their right to do so, which was previously required.  However it would be a good idea to have the first trust deed holder specifically waive the right to pursue deficiency judgement.

However a second trust deed holder can pursue a judgement if they don’t specifically waive it, even if they have approved the short sale.  If the property is sold, the second trust deed holder would have to sue the seller to obtain the deficiency judgement in order to place liens on any of the seller’s properties or garnish the seller’s wages.

Will the forgiven amount be taxed?

When short selling your Los Angeles home,  the IRS or Franchise Tax Board could consider the amount forgiven by the lender as income for the seller, and this would be taxed at ordinary income rate, which would be a severe blow to the seller.  But luckily, this is unlikely to happen due to the insolvency provision of tax laws, and Federal and California laws that were passed offering tax relief for cancellation of debt income in short sales.

The federal Mortgage Debt Relief Act of 2007 offers such provisions as:  if the home is the seller’s principal residence and a mortgage was taken out on the property to acquire, build, or improve it, then the forgiven debt will not be taxed.  Refinancing of the property will also not be taxed.  However, if cash was taken out over and above the original mortgage and was used for anything other than improvements to the property, then that amount will not be tax exempt.  So don’t go out and buy a car.  There is a cap on the cancellation of debt income:  $2M, or $1M if you are married and filing separately. California exemption is $500,000 or $250,000 respectively.

Be aware that these laws are due to expire at the end of 2012

What if I am not eligible for tax relief?

If you are short selling your Los Angeles home  and find that you are not eligible or only partly eligible for tax relief, you may be able to get relief by being insolvent under the tax laws.  If your liabilities are greater than your assets at the time of the Los Angeles short sale the tax laws would designate you as “insolvent”.  Depending on those liabilities the seller’s tax indebtedness could be greatly reduced or eliminated.

The benefit of the insolvency provision of the tax code is that the above restrictions – primary residence, residential income, money taken out and applied to the home only – do not apply.  To see if you qualify for the insolvency provision you should consult a tax professional.

Will I get a 1099 for the cancelled debt?

A short seller will most certainly receive a 1099 for the cancelled debt.  Even though it may not be taxed it does have to be reported.

If you are thinking of short selling your Los Angeles home,  you must use a listing agent familiar with the ins and outs of negotiating one of these difficult transactions.  While I am not a short sale agent, I have worked with experts in the field and will be happy to refer you to one.

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Comments(25)

Jeanne M. Gavish
Jeanne Gavish, Keller Williams Realty Elite Partners - Spring Hill, FL
Keller Williams Realty Elite Partners - CIPS,GRI,S

This is really good information, whether you are n Los Angeles or not.   Especially the part about insolvency.  Thanks for such an informative and concise summary of the process.

Aug 15, 2011 01:57 PM
Sheldon Neal
Bergen County, NJ - RE/MAX Real Estate Limited - Maywood, NJ
That British Agent Bergen County NJ

...well this is an easy one for me to click that *suggest* button for !  Fabulous summary of key questions when considering short sales and their tax implications ! Nicely done partner !

Aug 15, 2011 02:26 PM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Jeanne,  thank you for coming by.

Sheldon,  well thank you indeed.

Aug 15, 2011 02:39 PM
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

Lots of great information Jane.  It is good to have folks check with their accountant and attorney as well because sometimes foreclosure or even bankruptcy may make more sense in a give situation.

Aug 15, 2011 03:46 PM
John M. Scott
BRE # 01442690, Scott Keys Properties - San Francisco, CA
Broker / Owner San Francisco Bay Area

Excellent summary Jane! This would make a really good short sale disclosure document.

Aug 15, 2011 03:57 PM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Joan,  everyone should definitely consult with a professional.

John,  thanks.  Not a bad idea.

Aug 15, 2011 04:18 PM
Carla Muss-Jacobs, RETIRED
RETIRED / State License is Inactive - Portland, OR

This is a great post, and you're very honest in your closing sentence.  You recommend clients get a short sale agent that knows what they're doing!  Geez, how many agent say they know all about short sales . . . but leave their clients in a lurch because they don't follow-through.  After they get the listing they drop the ball.  Well written and well-stated!

Aug 15, 2011 05:36 PM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Carla,  thank you kindly. Yes.  It does take a particular expertise to get these short sales handled properly.

Aug 15, 2011 05:41 PM
Melissa Zavala
Broadpoint Properties - Escondido, CA
Broker, Escondido Real Estate, San Diego County

Hi Jane. You really do cover all the bases here. So much information that you could probably even break it down and write a few more posts--as if you were ever short on material. Life gives us so much material ;-)

Aug 15, 2011 06:36 PM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Melissa,  well thank you.  That is indeed praise coming from you. :)

Aug 15, 2011 06:39 PM
Michelle Gibson
Hansen Real Estate Group Inc. - Wellington, FL
REALTOR

Jane - VERY thorough information on Los Angeles short sale and Melissa's right you definitely have enough info to write a few more posts.

Aug 16, 2011 08:06 AM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Michelle,  well I will have to consult you, as you know way more than I :)

Aug 16, 2011 12:33 PM
1~Judi Barrett
Integrity Real Estate Services 116 SE AVE N, Idabel, OK 74745 - Idabel, OK
BS Ed, Integrity Real Estate Services -IDABEL OK

Jane, A great job of bringing out several details that short sale sellers need to consider prior to participating in a short sale. 

Aug 16, 2011 03:08 PM
Gene Mundt, IL/WI Mortgage Originator - FHA/VA/Conv/Jumbo/Portfolio/Refi
NMLS #216987, IL Lic. 031.0006220, WI Licensed. APMC NMLS #175656 - New Lenox, IL
708.921.6331 - 40+ yrs experience

Jane:  Absolutely great and timely post!  These are answers that many are seeking.  You provide them great assistance ... great guidance.  Fantastic job ...

Gene 

Aug 16, 2011 04:51 PM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

David,  thank you very much.  One of our CAR lawyers actually wrote an article that I covered this.

Judi,  thank you very much.

Gene,  thank you very much too.

Aug 16, 2011 05:55 PM
Surprise Arizona Realtor Jim Braun Sun City Grand Active Adult Communities
Coldwell Banker Residential Brokerage Jim Braun Sun City Grand Az - Surprise, AZ
Surprise AZ real estate Phoenix West Valley

Jane: Great presentation as always. This should answer many of the questions people have about short sales in your area.

Aug 17, 2011 02:00 AM
Wayne Johnson
Coldwell Banker D'Ann Harper REALTORS® - San Antonio, TX
San Antonio REALTOR, San Antonio Homes For Sale

Jane, I knew short sales were technically and emotially challenging, and your information just adds to my promise to myself to refer these to experts, at least for now. You made the complex more understandable.

Aug 17, 2011 05:48 AM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Jim,  thank you ver much.

Wayne,  it really does need to be handled by experts.  We can handle the emotional, but not the technical.

Aug 17, 2011 06:40 AM
Not a real person
San Diego, CA

Happy Thursday!

Aug 18, 2011 05:21 AM
Jane Peters
Home Jane Realty - Los Angeles, CA
Los Angeles real estate concierge services

Russell,  well thank you.  Good to know.

Aug 18, 2011 05:45 AM