No More Short Sales Deficiency Judgments, But Income Taxes May Still Lurk

On July 15, 2011, Governor Jerry Brown signed SB 458 into law with a declaration of urgency that made it effective immediately. This new law prevents deficiency judgments after a short sale and means those naughty lenders can’t come after you once the transaction is complete. Knowing about this new law will help you educate the bank so they don’t try to slip deficiency language into your settlement letter.

A recent blog article on this topic explains the deficiency issues with short sales. The comments ask if this is retroactive and the answer is NO. Those who have already gone through short sales are not protected by this new law and must seek bankruptcy protection and discharge for those deficiency judgments. Remember that all debts discharged through bankruptcy have no income tax liability.

Local realtors are excited about this new law and the California Association of Realtors put out a press release about the recent passage of this bill. What this bill means is that mortgage holders can no longer go after the seller for any deficiencies after the short sale closes. However, beware of the tax salesman!

The IRS and the Franchise Tax Board are currently exempting income taxes on canceled debts where it is a mortgage. I understand that this ends in 2012 and we have no information on whether this will continue. You can read more about the Mortgage Forgiveness Debt Relief Act and debt cancellation from the IRS directly. You MUST consult with your tax professional before deciding to sell your home short, as laws are constantly changing. This means that the time is right now if you have been waiting. The Franchise Tax Board also enforces this law and has extended its program through 2012. I expect we will see an increase in short sales next year as foreclosures continue to rise.

If you are facing a deficiency judgment from a prior transaction, or if you are concerned about the possible income tax consequences of a short sale, I suggest you talk to your professionals. Call your tax professional and consult with a bankruptcy attorney to make sure your obligation to pay that debt is eliminated. You may not need to file for bankruptcy if you hire a tax professional who is knowledgeable in this area of ​​tax law. Don’t delay or you may be on the hook for this debt after your short sale.