Update: Federal taxes on forgiven short sales

Update: Federal Taxes on Short Sales Forgiven in CA 2014 

Foreclosure and Short Sale tax forgiveness is a gift.

 Since the Mortgage Debt relief act of 2007 expired in December 2013 there has been much confusion over the issue of the IRS tax on short sales in California.  Although we do not have a law currently in place defining the forgiveness of Federal Taxes on Short Sales in California for  2014 we do have a documented opinion from the IRS thanks to Senator Barbara Boxer.

“The Internal Revenue Service Will Not Penalize California Families Losing Homes to Short Sale” 

The IRS originally replied to a letter from Senator Boxer on September 19,2013 to clarify that California families who have lost their homes in a short sale would not be subjected to a tax penalty for debt forgiven after the federal law prohibiting such penalties expires at the end of 2013.

Then on April 29,2014 the IRS wrote a second letter  to Senator Barbara Boxer adding a technical caveat to their previous assurance of no federal taxes on a short sale in California. The new letter continues to protect most California homeowners from receiving a large tax bill following the completion of a short sale, but relies on a different section of the California code for its analysis than the previous letter.

Leave it to the IRS to take a stance then further clarify it.

Further here are some interesting notes from California attorney Steve Beede regarding Debt forgiveness, taxes, short sales, foreclosures, etc..


“Since neither Congress nor the CA Legislature passed any extension of Debt Forgiveness Tax Relief beyond its 12/31/13 ending, everyone thought that tax relief was dead. If so, the financial damage from a short sale or foreclosure would become much greater.  But now the IRS and California tax officials have ruled that any short sale of a 1-4 unit residential property in California will be exempt from tax on the unpaid debt. Now, if they would extend this to foreclosures as well, the entire upside-down market could clean up faster.

In August 2013 California Senator Barbara Boxer sent a letter to the IRS questioning whether debt forgiveness taxes would be charged on short sales in California since the passage of SB458 (Code of Civil Procedure 580e). An IRS official responded on September 19, 2013 that there would be no such taxes because the California law rendered the debt “non-recourse”.   

At the time, I [Attorney: Steve Beedbe] questioned the reasoning used by the IRS since, if it were true, then Trustee Sale foreclosures should also be exempt from taxes (although I did not raise this question to the IRS). Meanwhile the CA taxing authorities matched the IRS decision and the real estate community rejoiced the at least with short sales, debt forgiveness tax could be avoided despite the end of the Debt Forgiveness Relief Act on December 31, 2013.    

However, on April 29, 2014, after receiving comments from California tax practitioners and its own review of California law, the IRS has issued a clarification. 

The new IRS letter indicates that forgiven short sale debt is not subject to cancellation of debt (COD) income only if it is non-recourse at its inception and that their prior letter was overly broad.  In their letter, the IRS states that in order for a debt to be non-recourse at the time of the short sale, the original debt must be used to purchase or build a 1-4 principal residence or a refinance of such debt. 

This determination matches up with the pre-existing IRS rules which have always exempted “purchase-money debt” on personal residences.”

Thank you Mr. Beede,  BPE Law Group, Inc. for your analysis.

Very confusing at best, but what else would you expect from the Federal Government and IRS?Laws about short sales and foreclosures

This information is not intended to substitute for personal tax or legal advice.  I encourage you to contact your legal and tax advisors directly regarding all tax and legal questions.

As we continue to recover from the Real Esate financial crisis in California there is no need to lose your home to foreclosure when so many resources are available.

Call me 310-663-9427 and let’s get you moving to new solutions.


Cindy Marty's signature default advocate and realtor.



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