What are the income tax ramifications?

Because every short sale situation is unique and complicated, there is no single tax answer for an individual who wishes to short sale their home. Current California laws and statutes protect most homeowners from any federal or state taxes when performing a short sale. In some situations such as rental or vacation properties, the money forgiven by a lender may be taxable according to IRS regulations.

An IRS Information Letter from April 2014 clarifies how to treat short sale debt forgiveness under California Code Code of Civ. Proc. 580e. The Civil Procedure generally allows the homeowner to avoid having to pay federal income tax or state income tax on debt forgiven through a short sale. The letter states that a lender who holds a deed of trust from either claiming a deficiency or obtaining a deficiency judgment from the homeowner after agreeing to a short sale, treats the homeowner's obligation as a non-recourse obligation for tax purposes. The letter and procedures stemmed from an expiration of the Mortgage Debt Relief Act at the end of 2014. It is recommended that people who have short sold their home speak to their accountant to make sure they are up-to-date on the most recent tax laws and procedures.