California state lawmakers passed SB 401 this week, which exempts homeowners who have lost their homes to short sales or foreclosure, or who have received loan modifications, from having to pay state tax.
From the Sacramento Bee report:
The bill extends the state ban from 2009 through the end of 2012. It also bans state taxes on federal stimulus grants for renewable energy projects.
Who is affected:
Primarily, the bill affects people who had debt forgiven as they lost homes in foreclosures, short sales and deeds in lieu of foreclosure last year – and through 2012 now. Also affected: those who got loan modifications that cut the amount they owe the bank.
In short sales, a bank might accept a sales price of $250,000 when it is still owed $350,000 on the home. In deeds in lieu of foreclosure, the bank simply takes back the house and may forgive what’s still owed. The difference is the forgiven debt. Borrowers can avoid state taxes on up to $500,000 in forgiven debt.
The Franchise Tax Board says the tax forgiveness measure mostly applies to people who refinanced their homes to get better interest rates or extract equity, and then had a short sale or foreclosure where debt was forgiven.
But the tax board also warned that refinanced dollars taken out as cash and spent on items other than home improvements may be taxable.
Who is not affected:
Those who bought houses and never refinanced before doing a short sale, loan modification or foreclosure are unaffected. In most cases the banks just take back the houses. There is no forgiven debt, and no tax bill, said the tax board.
Investors are also unaffected. They still must pay state taxes on forgiven debt. The bill affects only people who live in their home.