Fears rise that forgiven home debt will be taxed

SACRAMENTO — Northern California accountants say rising numbers of homeowners who used short sales or received loan modifications in 2009 fear they will be walloped by a cash-starved state government intent on taxing their forgiven debt.

It's impossible to ease the fears or specifically answer many questions, accountants say.

"We've had quite a few clients fall into that category," said Jennifer Neronde, office manager at Rocklin-based Cramer and Associates CPA.

Uncertainty reigns with less than six weeks before the April 15 filing deadline because the forgiven debt question has gotten caught up in a larger tussle over business taxes between the Legislature and Gov. Schwarzenegger.

It's headed for a Capitol showdown next week.

Monday, the Assembly is scheduled to vote on Senate Bill 32 X8, a bill by state Sen. Lois Wolk, D-Davis, that would ban the state from taxing mortgage debt forgiven in 2009.

Schwarzenegger is threatening to veto the bill over an obscure clause opposed by business groups. The clause establishes tax penalties on firms that file unfounded claims for refunds. Business associations believe it will unfairly punish them for tax-withholding decisions they claim are difficult to calculate. The clause, along with forgiven mortgage debt, is among dozens in the bill to align California's tax codes with federal codes.

"The governor would prefer that the provision be taken out of the bill and addressed in separate legislation," spokesman Mike Naple said.

The state gave homeowners who occupied their homes a pass on forgiven mortgage debt in 2007 and 2008. The federal government has backed off on taxing forgiven mortgage debt through the end of 2012. In the past, both treated forgiven debt as taxable income.

In a short sale, a lender might accept a sales price of $200,000 on a home for which it's owed $325,000. The $125,000 left unpaid is classified as forgiven debt, which used to qualify as taxable income. The Bush administration, backed by the real estate industry, blocked the IRS from taxing forgiven debt in 2007. It's a temporary measure to encourage borrowers to call lenders and negotiate alternatives to foreclosure.