The big question in 2015... Are Short Sales and Foreclosures Subject to FEDERAL Income Taxation?
According to the California Association of Realtors legal department.. the answer is Yes.
HOWEVER... the income is taxed / addressed differently, depending on several things, including whether there was a foreclosure, or a short sale (a sale where the lender agrees to reduce the amount owed in order to facilitate a sale).
What's the Good News Then...?
For the last few years, our California State Tax Laws have trumped the Federal tax laws... (Check this with a CPA and an Attorney!)
Another factor to remember: Is the debt in question considered "recourse" (the borrower is personally liable for the debt) or "nonrecourse" (the borrower is not personally liable for the debt).
What is "Nonrecourse" Debt?
California law calls a debt "nonrecourse" when a loan is made to purchase a one-to-four unit property and the borrower intends to occupy at least one of the units, (sometimes referred to as a “purchase money loan”) under the law or, when a seller carries back the note ("seller financing") for the purchase price of a property.
And... What is "Recourse" debt?
Examples of recourse debt are refinances of existing mortgages, home improvement loans, equity lines of credit, and loans other than seller financing. For example, refinancing your home, getting cash out, and paying for college tuition, a vacation, wedding, new vehicle, etc.
The lender can take the property back in this case, and the borrower may be personally liable for this kind of "recourse" debt.
Saving Grace: If the lender forecloses, using a trustee's sale, THEN, the lender waives the right to go after the borrower for the deficiency.
FYI: In order to go after a deficiency judgment, the lender must go through a judicial foreclosure process.
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