The IRS Driving A Stake Into The Heart Of California Homeowners?

IRS Is Figuring Out New Ways To Tax Homeowners On Short Sales And Loan Modifications. The Mortgage Debt Forgiveness Act (MDFA) is set to expire on December 31 and has some folks doing their best "Chicken Little" impersonation.

According to an article in “Mortgage Fraud Investigations” the IRS is “essentially figuring out new ways to sidestep the spirit of a law passed by Congress that exempts homeowners from declaring as income any forgiven debt from short sales or modifications.”

The proof is in the form of a letter written by Michael Montemurro of the IRS to our very own Barbara Boxer (D-CA). In August she wrote a letter to the head of the IRS asking ”whether a homeowner would have taxable cancellation of indebtedness income on a ìender approved short sale that qualifies under section 580e  of the California Code of Civil Procedure (CCP)”

You can read the IRS reply here.

How is the expiration of the MDFA going to affect California homeowners?

The obvious answer is “consult your tax professional” but in 2011, California enacted an anti-deficiency provision under section 580e of the CCP, which generally prohibits a lender who holds a deed of trust on a homeowner's principal residence from either claiming a deficiency or obtaining a deficiency judgment from the homeowner after agreeing to a short sale. The statute effectively limits lne homeowner’s liability to the amount the lender received on the sale of the principal residence, and the homeowner is not personalìy liable for the deficiency baiance (the difference between the loan balance and the sales price).

Because a good story should always raise more questions than it answers

Section 580e has certain exceptions to its anti-deficiency provisions. Also, "federal law may override Californians anti-deficiency provisions in certain circumstances. lf any state or federal law would have the effect of nullifying an obligations nonrecourse status, we would generally consider the obligation a recourse obligation subject to the application of the cancellation of indebtedness provisions of section 61(a)(12) of the Code."

It appears there is little chance for extension of the MDFA, the IRS letter clearly defines how a homeowner has to report the forgiven debt and for many California Homeowners there will be little to no tax liability (assuming they get expert tax advice).

Of course I could be wrong