BOE Member George Runner

Californians Who Short Sell Won’t Face State Tax Penalty

Back in September, I wrote a letter to the Franchise Tax Board’s Chief Counsel requesting a legal opinion on the potential tax consequences for a California resident who completes a short sale under existing California law.

I am pleased to announce that the Franchise Tax Board will follow the lead of the Internal Revenue Service and not impose a tax penalty on Californians who have sold their home via a short sale. In her response, FTB Chief Counsel Jozel Brunett stated “Since California conforms to the relevant portions 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.”

This is welcome news for Californians who have had to short sell their homes this year. We learned last month they wouldn’t face a federal tax penalty, and now we know they won’t face a state tax hit either.

Initially, FTB staff indicated they would need guidance from the IRS before providing an answer. That guidance arrived last month in an IRS letter to Senator Barbara Boxer regarding the expiration of the Mortgage Forgiveness Debt Relief Act. The IRS opined that debt forgiveness involving non-recourse loans held by California homeowners will not be viewed as taxable income.

A legislative effort to extend tax protection for California short sales derailed this year. However, the FTB’s announcement that it will conform with the IRS ensures continued protection for taxpayers without the need for legislation.