Understanding the California shortsale tax is necessary when contemplating selling a home for less than what is owed on it (selling a home “short, ” in other words), which is a situation many homeowners in the Golden State are being forced to confront in our challenging economic environment. Not only has the bottom fallen out in the housing market in many areas, but tax laws are generally not too forgiving, sad to say.
During the go-go real estate years in California, housing prices were increasing by leaps and bounds every year. Many folks bought when the market was good, paying prices for much more home than they’d normally be willing to chance on the assumption that prices would keep increasing and the ARM (adjustable-rate mortgage) they’d taken out wouldn’t adjust before they could sell for a profit.
Unfortunately, many folks are now sitting on homes that are worth far less than what is owed, with an ARM that has now adjusted upwards (meaning a new monthly payments of hundreds more) or are stuck with a home, and out of a job in this recession, that can’t be sold and a mortgage that can’t be paid no matter how hard they try. Additionally, they can’t get the home refinanced.
Given all the above, it’s understandable that a homeowner may try to get permission from the mortgage holder to attempt to a shortsale in order to avoid letting the home be foreclosed upon by the lien holder (usually a bank or other financial institution). It can be a sort of “win-win” for both the owner and the bank, in that the bank will at least get something for the home and the owner doesn’t take a fatal blow to his or her credit history.
All is not completely rosy in the transaction, though, as the California shortsale tax may have to be addressed. Let’s say that a home that is saddled with a 500, 000 dollar mortgage undergoes shortsale and goes for 300, 000 dollars when a ready, willing and able buyer steps forward to make an offer and purchase the property.
Federal taxes on the difference between what is owed and what the property sold for can generally be waived under the Debt Relief Act of 2007 (it’s in effect for 2009). However, California will tax the forgiven debt (200, 000 dollars) at up to a 9. 3 percent rate, meaning a nearly 19, 000 dollar tax bill could result.
Normally, this tax liability will go into effect as soon as the old homeowner receives the Form 1099 from the bank that is forgiving the debt difference (that 200 grand). Of course, not many folks engaging in a short sale will have that kind of money lying around to settle a state tax debt resulting from a short sale, so arrangements will have to be made to pay down the amount or settle with the state for a reduced payment.
At any rate, conducting a shortsale – which might only reduce a person’s overall FICO credit score by around 200 or points – will always be better than letting a home go into foreclosure. The fatal effects of that action (foreclosure) can follow a person around for many, many years and may even prevent him or her from ever getting another mortgage.
