Performing Your Civic Duties

Still Struggling With Your Underwater California Mortgage? Could Relief Be Headed Your Way?

If you purchased your California home during the most recent real estate boom, you may be struggling with a mortgage that is significantly higher than your home's value -- often deemed an "underwater mortgage." Although a number of federal and state mortgage relief programs can help make your home more affordable by modifying your interest rate or mortgage term (or even forgiving a portion of principal), there can be some very steep tax consequences associated with the decision to pursue loan modification. In some cases, the assessment of state income taxes on forgiven mortgage principal could put you in a worse place than you'd have been if you never sought mortgage modification in the first place. Read on to learn more about how a recent legislative proposal introduced by Senator Cathleen Galgiani could provide relief to California homeowners struggling with the potential tax consequences of a deed in lieu of foreclosure or short sale.

What are the financial implications of short selling your California home or seeking a mortgage modification?

Under the principle of imputed income, many states (and the federal government) will assess income taxes on forgiven debt. This treats the amount of debt forgiven as an equivalent amount of income to be taxed according to state or federal tax rates. For example, if you sell your home at a short sale for $15,000 less than the mortgaged amount and this deficiency is forgiven by your mortgage lender, you'll be taxed on an additional $15,000 in income for the tax year in which you sold your home. This principle also applies to homeowners who had a portion of their mortgage principal forgiven pursuant to federal regulations or who sought a deed in lieu of foreclosure (often called "cash for keys").

For low-income homeowners, retirees on a fixed income, or those whose mortgages were heavily underwater, the assessment of taxes on this on-paper-only income can be an enormous burden. 

What does Senator Galgiani seek to change about this process with Senate Bill 907?

This California Senate bill proposes to eliminate state income tax on most mortgage-related imputed income, potentially protecting many families from being saddled with a heavy tax bill the year after they short sell a home or seek forgiveness of a portion of mortgage principal. Senator Galgiani's bill has enjoyed some bipartisan support from those whose constituents have been affected by this tax provision, and stands a high chance of passage this session. If you've already received a tax bill from your short sale, it may be worth a call to an attorney to see if this legislation can help you; and if you're considering mortgage modification or a short sale, it could be prudent to wait until this bill is put into law.