How will the expiration of the Mortgage Debt Relief Act of 2007 affect California Homeowners?

The Mortgage Debt Relief Act of 2007 is set to expire on December 31, 2013.  Congress ended its recent session without addressing the Mortgage Debt Relief Act of 2007’s looming expiration so it appears that another extension will not occur.  The Mortgage Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their principal residence that is incurred as a result of mortgage restructuring or debt forgiveness as a result of a short sale.

While the expiration of the Mortgage Debt Relief Act of 2007 will cause taxpayers throughout the country to fret about what to do with their upside down mortgages, homeowners in California appear to be protected.  Senator Barbara Boxer (D-CA) sent a letter dated August 28, 2013 to the Internal Revenue Service (“IRS”) asking for clarification on whether California homeowners would have taxable cancellation indebtedness income as a result of a lender approved short sale pursuant to Section 580e of the California Code of Civil Procedure (“CCP”).  CCP §580e is an anti-deficiency statute that basically states if a lender approves a short sale the lender is prohibited from either claiming a deficiency or pursuing a deficiency judgment from the homeowner after agreeing to the short sale (to view CCP §580e please click the following link CCP 580e). The IRS responded in a letter dated September 19, 2013 (“IRS Letter”) and stated that CCP §580e effectively changes the nature of loans that have successfully completed short sales from recourse loans to non-recourse loans.  The IRS Letter states “We believe that a homeowner’s obligation under the anti-deficiency provision of Section 580e of the CCP would be a nonrecourse obligation to the extent that, for federal income tax purposes, the homeowner will not have cancellation of indebtedness income.”  To view a copy of the IRS Letter please click the following link: Likewise, in a letter dated December 4, 2013 (“Franchise Tax Board Letter”), the State of California Franchise Tax Board in referencing the IRS Letter stated “Since California conforms to the relevant portions of the of the federal tax law governing the forgiveness of nonrecourse and recourse indebtedness, California would follow the federal treatment for the CCP section 580e transactions.  As such, the homeowner may have gain on the short sale, but would not have cancellation of indebtedness income.”  To view a copy of the Franchise Tax Board Letter please click the following link:

What does all of this mean in plain English?  It appears to mean that because CCP §580e takes away the ability of lenders to purse deficiencies as a result of approved short sales, the IRS and State of California are treating the resulting loans as nonrecourse loans which means that there is effectively no debt forgiveness.  For California homeowners desiring to short sell their property in 2014 this means that, despite the fact that the Mortgage Debt Relief Act of 2007 expires on December 31, 2013 these homeowners can short sell their homes with the peace of mind that any debt forgiven pursuant to CCP §580e will not result in taxable income.

The California Association of Realtors® (“CAR”) issued a press release on December 4, 2013 announcing that CAR was pleased with the clarification provided by the IRS and the California Franchise Tax Board stating “California homeowners can now avoid foreclosure or bankruptcy and can opt for a short sale instead, without incurring federal and state tax liability, even after the Mortgage Debt Relief Act of 2007 expires at the end of this year.” To view a copy of the CAR press release please click the following link:

Michael Gaddis is a real estate broker and licensed California attorney specializing in assisting homeowners located in San Diego County. If you are a homeowner seeking to short sell your home and you are located in San Diego, Orange, Riverside or Los Angeles Counties you may contact Michael Gaddis at 888-242-2272.


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