Silver Lining to Foreclosures in 2013

If a foreclosure on your home isn’t bad enough, enter the tax code for an extra “kick you when you’re down” provision known as Cancellation of Debt (COD) income.  In a typical foreclosure the lender takes the property securing the debt in full satisfaction of the debt.  In many cases this transaction is considered a sale of the property for the amount of the debt.   If the fair market value of the property is less than the amount of the debt there is a potentially taxable gain, even when there is no cash received.

In 2007 Congress provided for a special exclusion of this type of gain by allowing individuals to exclude up to $2 million of COD income on their principal residence.  That law was originally scheduled to be effective through 2010 and was extended once to apply to COD income through 2012.  The American Taxpayer Relief Act of 2012 extended this provision one more time, but only through 2013.  This extra year is the silver lining for those individuals faced with a foreclosure in 2013.  Without the extension, any COD income would be taxable if the individual did not qualify under one of the other exceptions to COD income.

It is important to note that with a nonrecourse loan there is no COD income.  In California, a purchase money mortgage on a 1 to 4 unit property that is the buyer’s principal residence is always nonrecourse.  The problem only arises when the initial loan is refinanced, or a subsequent 2nd or later loan is made on the property.  Any refinance of the original loan eliminates the beneficial nonrecourse provision of the California statute.

While the Federal law was extended through 2013, California did not extend the provision of the state law allowing for exclusion of COD income on a principal residence past the end of 2012.  California’s provision for excluding COD income was never quite as generous as the federal law.  The California provisions allowed for exclusion of up to $500,000 of COD income.  In 2013 there is no specific exclusion for COD income from a principal residence for California taxes.

Do you need more information?  You can read a more expanded article here.  

Calculating COD income for tax purposes can be confusing.  The tax professionals at Seid & Company, CPAs have all had specific training in how to handle foreclosures, short sales and other COD income exceptions and exclusions. 

Need even more information?  Call for an appointment to talk to one of the tax professionals at Seid & Company, CPAs.