Short-Sale: Effects of CA Senate Bills 931 and 458

Originally published in the Pacific Grove Hometown Bulletin

March 21, 2012

This past summer I wrote a series of six articles on short-sales and foreclosures.  I am still receiving calls/e-mails from people all over California that have seen the articles republished on my website.  One caller, a bankruptcy attorney from the Sacramento area, thought that an article addressing California Senate Bills (SB) 931, effective January 2011, and SB 458, effective July 2011, would be helpful.

Prior to these bills, there were cases where a lender would agree to a short-sale and the homeowner would give the home back thinking the remaining recourse debt was cancelled.  Later, they would find the lender was still pursuing them for the deficiency and that the papers they signed did not actually cancel the remaining debt.  SB 931 partly addressed this by not allowing the primary lender to pursue you for the deficiency once they agreed to a short-sale.

The problem then arose that junior lien holders such as a second loan or HELOC would continue to pursue the owner for the deficiency on their loan because the bill did not require them to cancel their remaining debt.  Hence the passage of SB 458 which does not allow them to pursue the deficiency either.  These bills have now both been codified into law in California Code of Civil Procedure Section 580e.

It is clearly good news that you will not be pursued for the debt, but you will still have a wrestling match with the taxing authorities.  The new law requires the lenders to accept the settled amount as payment in full and to fully discharge the remaining amount of indebtedness.  Since the lender will be getting a tax deduction for your bad debt, you will be getting a 1099-C and will have taxable income unless you can exclude a portion or all of the debt under the provisions in Internal Revenue Code Section 108 and related Treasury Regulations.

The new law makes junior lien holders less willing to accept a short-sale, since they are often giving up their right of pursuit and get very little out of the deal.  Kristin DeMaria, a short-sale attorney with Mallery & DeMaria PC in Monterey said, “Under this new law, the junior lien holders can no longer ask the sellers for money, but they can say no to the short-sale.  The sellers, however, can voluntarily offer money and may want to do so to avoid pursuit for the full deficiency after a foreclosure on a recourse second loan.”

For tax purposes, it is highly important that you file a timely tax return with the correct forms, statements and calculations, otherwise you will unknowingly waive your right to any possible discharge of cancelled debt to which you may be entitled.  Having an attorney and a CPA that specialize in the respective negotiation and tax issues is key to navigating these waters successfully.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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