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Continued legislative stalling on California Senate Bill 30 could mean big tax bills for thousands of San Diegans who have already sold or who may sell their homes this year under agreement from their lenders to accept a discounted payoff.

Under the terms of what the industry refers to as a short sale, a seller who owes more than their home is worth has an opportunity to sell the property, using whatever money is available after transaction costs such as real estate agent commissions, escrow and title fees, and county taxes to pay off loans against the property, even if the cash available at that point is not sufficient to cover the full loan balance. The former owner usually walks away with nothing, sometimes receiving a few thousand dollars to cover the cost of moving out of the home and into an apartment or other rental.

Typically, any loss a lender agrees to take has been counted by both the state and the IRS as direct income – meaning that if a borrower facing foreclosure sold a home at a $50,000 loss, he or she would owe regular income taxes based on that loss, and would possibly be pushed into a higher tax bracket when the benefit from the lender’s loss was added to the former homeowner’s regular income.

Since the housing crash of the late 2000s, however, both the federal government and the California legislature have passed (and repeatedly extended) legislation exempting borrowers losing their property via short sales rather than foreclosure from having to pay these taxes. The federal law’s latest extension expires at the end of the year, but a parallel bill granting exemption from state taxes has been stalled since March. It currently sits with the Assembly Appropriations Committee, after having passed the state Senate in May.

The bill remains stalled due to its linkage to SB 391, which would impose an additional $75 recording fee for each real estate-related document filed in a county recorder’s office. Proponents say that the money, which would be earmarked for affordable housing programs, would expand access to housing for low-wage workers and those displaced by the loss of their homes due to foreclosure or short sale. Opponents, including industry trade group California Association of Realtors, say that the bill “does not have the support necessary to pass on its own merits,” and that failure to act in the short term could result in tens of thousands of former homeowners being presented with a state tax bill in January that they’ll be unable to pay.

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