Research Paper on "California Tax Payers Who Commit"

Research Paper 3 pages (1208 words) Sources: 3

[EXCERPT] . . . .

California tax payers who commit a short sale is to report any debt forgiven as an extra source of income. This could increase the tax liability of the person resulting in inceased payments to their income tax.

If a cancellation of debt occurs, the total amount of the debt forgiven is reported by the lender to the IRS on a form 1099-C and usually translates to taxable income. There are however certain circumstances that can keep a person from having to pay any taxes on the cancelled debt such as bankruptcy, Qualified principal residence indebtedness, and insolvency among other situations. Since Danny has neither bankruptcy or insolvency, most likely he will not be exempt.

Short sales have their advantages and disadvantages. Danny made home improvements to a home that was supposed to be worth $1,500,000. He got an offer of only $600,000. Instead of taking the loss completely he opted for a short sale that has the ability to grant him complete debt forgiveness of the amount left over after the $600,000 payment. Danny managed to sell $600,000 worth of home. The potential $900,000 left over can be completely forgiven with the only payment being having to pay tax on the forgiven leftover amount.

If homeowners somehow managed to have their homes sold under a short sale before there is a tax lien put on the home from any tax collector, then there can be no tax lien established on the property to secure the debt. This signifies a substantial advantage for the homeowner due to the new options made available to the homeowner and the limited amount now owed by the homeowner. If it were not for the short sale, Danny would have been forced to have the inability to sell his property under the restrictions of the taxlien.

The disadvantage of a short sale is that it is often a long and tedious process often requiring a lawyer. If one is able to manage to get the short sale done, any amount forgiven through the short sale must then be reported by the homeowner in their taxes. This can lead to increased tax liability and having to pay more for their income tax.

Cancellation of debt is almost the same thing as a short sale with the consequences slightly being different then a short sale. "If the loan is a recourse loan, then depending on the facts, you may have COD income, and potentially a reportable gain, in which case you would want to determine if one of the provisions in IRC section 108 would apply, allowing the COD income from the discharge of indebtedness to be excluded." (Foreclosure and Short Sales 2012) The consequences being that the cancelled debt may or may not be qualified for taxation depending on any qualifying exemptions. Since Danny is not bankrupt or insolvent, it is most likely he would have to pay tax on the cancellation of debt income.

Some of the exemptions that quality for a person to not have to pay tax on cancellation of debt income are the following:

Qualified principal residence indebtedness: This exception is thanks due in part to the creation of the Mortgage Debt Relief Act of 2007 and applies to most homeowners, in this case Danny.

Bankruptcy: Any debts dismissed through bankruptcy do not qualify as taxable income..

Insolvency: Is almost like bankruptcy in the sense that the total debts owed are more than the fair market value of a person's total assets.

Non-recourse loans: A non-recourse loan is a loan that the lender's only fix in case of certain default which is to reposses any… READ MORE

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