short sale lawIn the real estate market, a short sale is the sale of a property under mortgage where the sale price is less than the balance of the mortgage. The bank receives the proceeds from the sale and may or may not relieve the borrower of the remaining balance. In California, laws are in place to manage the short sale process. Generally, a short sale saves banks from foreclosure expenses, and prevents borrowers from damaging their credit histories.

Short sales in California allow homeowners to avoid foreclosure by selling a home for less than they owe on it. Successful short-sale transactions transfer properties from the distressed seller to a qualified buyer. California short-sale transactions have certain safeguards in place to protect sellers from possible legal consequences. Neither seller nor buyer is obligated to use real estate lawyers in the transaction, but seeking clarification in complicated sales is a good idea.

In order for lenders to consider a short sale, homeowners in California must meet certain requirements. The homeowners must demonstrate ongoing and long-term financial hardship. In addition, they must be unable to refinance the mortgage in order to make it affordable. Some lenders ask sellers to put the property on the market as a normal sale first, to confirm that the market will not support the higher asking price. When all options have fallen through, primary lenders might adjust to the short sale. Rather than go through the headache of foreclosure and disposition of a potentially blighted property, they take the loss and move on.

Here are the short sale related laws in 2014 to find out if you do or do not have to pay the tax after a short sale in California. Also learn about how lenders are prevented from coming after California homeowners and rental property owners after a short sale.

  • Do you have to pay tax after a short sale in California?

The good news in 2014 is that the California Franchise Tax Board has clarified with the Department of Treasury that California families who successfully complete a short sale on their primary home may not be subject to California state income tax liability on debt forgiveness they never received in a short sale as long as they meet several conditions such as:

  • Short sale is on a primary residence
  • The property is located in California.
  • The property is 1-4 units.
  • The loan on the home is a non-recourse loan.
  • The loan is a purchase money loan.
  • Do you have to pay the IRS tax after a short sale?

Cancellation of Debt income resulting from a short sale is not always taxable according to the IRS. There are some exceptions that you can claim to avoid the tax resulting from a short sale according to the IRS. The most common situations when cancellation of debt income on is not taxed by the IRS include:

  1. Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners which expired in 2013.
  2. Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
  3. Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets. With the insolvency exclusion, you may be able to exclude the canceled debt income after a short sale of a primary residence or rental property to the extent that you were insolvent immediately before the cancellation of debt.
  4. Certain farm debts
  5. Non-recourse loans
  • Was the Mortgage Debt Relief Forgiveness Act extended in 2014?

It generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, short sale, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. The Mortgage Forgiveness Debt Relief Act of 2007 applies to original or refinanced loans that were used to acquire, build, or improve upon on your primary home. Mortgage Debt Relief Forgiveness Act not being extended in 2014, many homeowners may not have to pay California state income taxes on a short sale assuming they qualify. Also, that not all cancellation of debt income resulting from a short sale is taxable by the IRS. 

  • SB 931 Protection from Liability after a short sale on a First Mortgage in California:-

When the first mortgage holder of somebody loan accepts full payment and satisfaction of his entire outstanding first loan from the successful completion of the sale of home in California, lender is prevented from pursuing a deficiency against that person even after a short sale. This means to a homeowner in California is that this releases you from further liability when the bank accepts and approves the completed short sale.

  • SB 458 Protection from Liability after a short sale on a Second Mortgage in California:-

SB 458 Effective as of July 15, 2011, California homeowners who sell their homes through a short sale and who have subordinate loans such as home equity line of credit (HELOC) or second mortgages are now extended the protection against deficiency in a short sale. This means that if your second mortgage lender agrees to the short sale, your lender must accept the proceeds from the short sale as a payment in full of the outstanding balance of the loans.