SB 1055 seeks to alleviate potential tax on mortgage foreclosures

On mortgage foreclosures

Would conform California to key parts of the federal mortgage forgiveness debt relief law

As the mortgage foreclosure crisis deepens, actions at the state and national level aim to offer some relief to affected homeowners. On December 20, 2007, President Bush signed the federal Mortgage Forgiveness Debt Relief Act of 2007. Among other things (see below: "Other provisions of the federal legislation"), this law removes the potential tax liability on indebtedness (i.e. a principal residence mortgage) that is forgiven or discharged by the lender, up to a maximum of $2 million for married filing joint taxpayers, and $1 million for single filers. To be considered a principal residence, the owner must have lived in the home for any two of the past five years.

In California, proposed legislation would provide conformity with the federal Mortgage Forgiveness Debt Relief Act of 2007, target abusive mortgage lending practices, and provide aid for struggling homeowners. On January 7, 2008, California Senator Mike Machado announced Senate Bill (SB) 1055 (co-authored by Senators Michael Machado, Linden; and Lou Correa, Santa Ana). SB 1055 addresses tax relief by excluding forgiven mortgage debt from income for state income tax purposes (see related article in our October 2007 issue: Foreclosures and the next wave). Like the federal law, SB 1055 would take effect immediately.

If it passes, SB 1055 will conform to specified provisions of the federal Mortgage Forgiveness Debt Relief Act of 2007 – with a notable difference. For California taxpayers, the period of excludable discharges would be from January 1, 2007, to December 31, 2008. The federal period of excludable discharges is from January 1, 2007, to December 31, 2009.

Other provisions of the federal legislation

Although most attention is focused on removing the potential tax liability of principal residence debt that is forgiven by the lender, the federal Mortgage Forgiveness Debt Relief Act of 2007 contains additional provisions¹. These additional provisions were not included in SB 1055, thus California would not conform. Briefly, these include:

Extending the tax deduction for mortgage insurance premiums through 2010.
Establishing two new alternative tests for cooperative housing corporations’ qualification to deduct tax payments paid to the co-op housing corporation:
- Eighty percent or more of the total square footage of the corporation’s property is available for residential use by tenant-stockholders.
- Ninety percent of the co-op housing corporation’s expenditures are for acquiring, constructing, managing, maintaining, or caring for its property, for the benefit of its tenants-stockholders.
Allowing members of a qualified volunteer emergency response organization, i.e., an organization that provides firefighting and emergency medical services, to exclude state and local tax benefits, and certain payments for services from gross income.
Allowing certain full-time students who are single parents, and their children to live in housing units that are eligible for low-income housing credit if their children are not dependents of another individual.
Allowing a surviving spouse to exclude from gross income up to $500,000 of the gain from the sale or exchange of a principal residence owned jointly with the deceased spouse. The sale or exchange must occur within two years of the death of the spouse, and other ownership and use requirements must be met.
Increasing the penalty for failure to file a partnership return, and extending the number of months in which such a penalty can be imposed from five months to 12 months. This provision also limits disclosure of tax return information that includes individual taxpayer identity information.
Imposing an additional penalty on S corporations for failure to file required tax returns.
Amending the Tax Increase Prevention and Reconciliation Act of 2005 to increase the estimated tax payment due in the third quarter of 2012 for corporations with assets of at least $1 billion.

1 (From Library of Congress THOMAS)