Short Sale Tax Relief

The Internal Revenue Service is putting things right by not taxing non-existent income on short sales for single-family homes. If that doesn’t make much sense, it’s because you are a logical person who can’t understand why anyone would get taxed on non-existent income. However, that’s what was happening.

A short sale, you will recall, occurs when a house is sold for less than is owed on it – for example, if the buyer owes $325,000, but the house will only sell for $200,000. If you bought your home for $400,000 in 2006 with $50,000 as a down payment, you would have a loan of $350,000. Let’s say you lived there seven years (the average time people live in one house). By 2013, you’ve paid another $25,000 toward the loan, so you now have a loan of $325,000 (or $75,000 of equity in the property). Between 2006 and 2013, the housing market tumbled, so when you sold the home in 2013, you were only able to get $200,000 for it.

When you sell a home, there are costs associated with the transaction (realtor fees, inspections, repairs, etc.). After paying those costs, you actually receive $186,000. You pay that toward what’s left on your original loan, and you’re short by $139,000. Because you used a good realtor who negotiated with the lender to approve a short sale, the bank waived the $139,000.

The federal government understands that you never got the $139,000, but the State of California isn’t quite so understanding. They say you owe them tax on the $139,000; they consider it “debt relief” even though you didn’t actually receive it. So, after losing your $50,000 down payment and the additional $25,000 of principal you paid over seven years, the State of California wants you to send them up to $14,000 in taxes on money you never received.

The State of California is looking for revenue wherever it can find it. The State wanted to link two unrelated bills – the bill that waived the debt relief (so you didn’t have to pay taxes on non-existent income) with another bill that was designed to collect $75 per recorded document on all non-sale transactions (e.g., refinances, new deeds, etc.). There are about two dozen documents for those transactions, so refinancing your home, for example, would have gone up about $500 in recording fees paid to the State of California. Your elected representatives were trying to limit legitimate deductions while raising taxes on non-sale transactions.

Happily, over the objection of the state legislators, the IRS issued regulations forcing the state to waive the tax on the uncollected income. As for the other bill, many REALTORS are working hard to limit the additional fees for non-sale transactions to save our clients money. Stay tuned.


Next time I’ll write about the California Homeowner Bill of Rights. If there’s something you would like me to write about or if you have questions about real estate or property management, feel free to contact me at or visit our website at If you’d like to read previous articles, visit my blog at Dick Selzer is a real estate broker who has been in the business for more than 35 years.

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