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Short Sale California Tax Information

If you’re considering a short sale, it’s important to have a basic understanding of short sale California tax. The IRS and the California State Board of Equalization might tax you as the direct result of the sale or transfer of your home, unless you take precautions. Let’s take a look at short sale California tax information.

Capital Gains Tax

The gain or loss on the disposition or sale of your property is generally taxed as a capital gain. In a California short sale, if the property is sold for more than your investment in the property (i.e., purchase price plus improvements), then you might be required to pay capital gains tax. The IRS offers up to a $250,000 capital gains tax exclusion for individuals or $500,000 exclusion for married couples. If there is a capital loss, but the property was a rental, then the capital loss might be used to offset any forgiveness of debt.

For more information on capital gains tax, refer to IRS Publication 523. This is a complex topic, and Proper-t-Solutions strongly recommends you discuss California short sale taxes with your tax professional to ensure you will not be required to pay taxes that could otherwise be avoided.

Taxes on Forgiveness of Debt

In a California short sale, if any debt is forgiven by the lender, it might be taxed as ordinary income.

Exemptions to this exist if the homeowner was bankrupt or insolvent (i.e., has debt that exceeds assets) immediately before the debt was forgiven. The IRS also provides tax exclusion in cases where the homeowner has not taken out cash during a refinance on the loan.

Most homeowners will not have an issue with taxes on forgiveness of debt in short sales because they’re either insolvent, almost insolvent or have not taken out cash. If the homeowner is almost insolvent, a slightly lower selling price could remedy the situation and not affect the homeowner financially. Regrettably, real estate agents often structure the sale without looking at this very important issue.

Homeowners are most likely to have difficulty with taxes on forgiveness of debt if they are not insolvent and they have taken out cash on a loan refinance. Furthermore, these homeowners may not be the best candidates for a short sale because the lender must be willing to approve their hardship. These types of cases tend to be some of the most difficult to resolve, as the lender will want to use the homeowner’s assets for the repayment of the debt. These cases generally require additional planning and assistance to resolve.

For more information on this topic, review IRS Publication 4681. Due to the complexity of the California short sale tax code, property owners should discuss any proposed transactions with their tax professional.

Avoiding California Short Sale Taxes

In order to avoid short sale California tax, it’s critical that your short sale is structured with these taxes in mind. This includes pricing the home correctly and considering whether you are solvent or insolvent. Otherwise, you risk paying California short sale taxes you might have avoided.

Proper-t-Solutions is available to assist you, along with your tax professional, in creating a short sale plan that will help you avoid paying short sale California tax. Contact us today to learn more!