State Tax Relief for Forgiven Home Debt

Yesterday, Governor Schwarzenegger signed into law a piece of legislation that will provide debt forgiveness to thousands of Californians. This measure provides tax relief on mortgage debt forgiven in a short sale, foreclosure, or loan modification. Prior to this bill, California homeowners were exempt from owing federal taxes on the forgiven mortgage debt, but still were required to pay California taxes as if the forgiven debt were income. This bill has become law just in time for people to take advantage of it before this Thursday’s tax filing deadline.

State lawmakers approved the bill late last week. The bill, SB 401, by Sen. Lois Wolk (D-Davis), bans state taxes on up to $500,000 in forgiven mortgage debt and also prevents the state from taxing federal stimulus funds as additional business income when steered to renewable energy firms.

The state Franchise Tax Board estimates approximately 100,000 Californians will be spared from $34 million in state taxes through 2012 as a result of the new law.

The tax relief plan only applies to people who lost homes in which they actually lived. According to the Franchise Tax Board, investors are not beneficiaries of the tax break and still must pay state taxes on the forgiven debt. State officials say qualified taxpayers don’t have to do anything to get the tax break. Those who qualify for federal relief will automatically get the state relief.