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Congress in conflict over taxation of debt-cancellation income

This is a follow-up to a piece on the tax implications of mortgage debt forgiveness that we did toward the end of last year.

A lot has happened since then. At the national level, the Mortgage Forgiveness Debt Relief Act ran out on December 31, 2013. And its reauthorization has become embroiled in partisan conflict.

Meanwhile, there are also California-specific aspects to this story. In this post, we will update you on the mortgage debt-forgiveness issue. It's an issue that affects many homeowners who experience foreclosure or are able to negotiate a short sale.

California did not follow Congress's lead in creating a tax exemption for income from forgiven mortgage debt following the housing crisis that precipitated the Great Recession.

Instead, California passed only a temporary exemption that lasted a mere one year. But now the federal exemption has also lapsed.

Regarding short sales, however, there is a bit more clarity on debt-cancellation income issues than there was at the end of last year. As we noted in our December 11 post last year, Senator Barbara Boxer had discussions with the IRS about whether debt cancellation income must be recognized after a short sale.

The upshot of these discussions was that the IRS has allowed an income tax exemption for income from short sales in California. This is because of the IRS's interpretation of a California law on the treatment of debt that is considered "recourse" debt.

At the federal level, however, conflict over reauthorization of the Mortgage Forgiveness Debt Relief Act continues to rage.

Source: Los Angeles Times, "Congressional inaction on debt forgiveness bill affects short sales," Kenneth R. Harney, June 8, 2014

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