California Continues to Tax Forgiven Recourse Debt

Today we look at one family in San Diego hoping for debt forgiveness that isn't going to happen.

Today's featured property is a nice Woodbridge cottage bouncing off the illusory bottom.

Irvine Home Address … 4 SWEET RAIN Irvine, CA 92614

Resale Home Price …… $629,000


Love is like oxygen

You get too much you get too high

Not enough and you're gonna die

Love gets you high

Time on my side

I got it all

I've heard that pride

Always comes before a fall

Sweet — Love Is Like Oxygen

Appreciation is like oxygen, you get too much prices get too high, not enough and your gonna die — or at least be forced to pay down debts — a fate antithetical to a borrowing dependant lifestyle.

Recently, I wrote about The Coming Tax Nightmare Over Forgiven Mortgage Debt in California, and recently another story was written about the Hefty tax bill may hit those who lost home.

San Diegans who have lost their homes through foreclosure or short-sales thought they had emerged from the dark times and could start rebuilding their lives.

Then the state tax man came calling.

With less than six weeks before taxes are due, an estimated 16,000 former homeowners statewide will owe $15 million in extra income taxes this year and $29 million through 2012.

Today we look at one family lamenting the $20,000 tax bill they must pay for their failed speculation.

[March 2, 2010 | Photo by Charlie Neuman. Bonnie and Clyde are facing a California tax bill of up to $20,000 because, they have found, the state treats short-sales differently than the IRS.]

Phyllis Roth, 63, a tax preparer, said she did not realize until recently that the state would treat the short-sale differently than the Internal Revenue Service would. She estimates her state taxes at $15,000 to $20,000.

“I didn’t call anybody,” she said. “I was looking online and didn’t see anything. That’s what happens when you rely on yourself.”

Brilliant marketing for her tax preparation business, "Let me help you miss a $20,000 tax obligation. I did."

For the Roths, who continue to own a previous home and have other assets, their nearly $200,000 in losses does not cancel out their other holdings. The couple said they normally operate conservatively and only bought the home, which they lived in while their son continued to live in their first house, so they could sell it at a profit and pad their retirement accounts.

“If we have to pay it, we’ll pay it,” Phyllis Roth said of the taxes. “It’s less money to retire on, but it’s not the end of the world.”

If we have to pay it? Sure, let's take our broken State budget and carve out a tax break for HELOC abusers and everyone else who lost money speculating in the housing market. That should provide a great incentive for frugality and curb speculation. Not.

Congress exempted most homeowners from the extra federal tax through 2012, and the state followed suit for 2007 and 2008 but did not extend the provision last year. The state Assembly may vote tomorrow on a bill to repeal the tax, but Gov. Arnold Schwarzenegger vetoed such a bill last year over unrelated provisions.

“The state of California is seriously upside down financially, and I think the governor will probably veto it again,” Nemeth said.

H.D. Palmer, a spokesman for the Department of Finance, said Schwarzenegger remains opposed to the bill in its present form but has not announced whether he will veto it again. Other versions of the tax repeal are in the hopper and could be passed next month, legislators’ analysts said.

Failure to halt the tax could cost Jack and Phyllis Roth of Fletcher Hills as much as $20,000 in state income taxes this year — they paid $781 last year — because of the home they sold short in Flinn Springs in November. They bought it in 2004 for $545,000, invested $50,000 in improvements, and then saw its value fall by one-third before they sold it for $410,000. The result was about $190,000 in net loss that was forgiven by the Roths’ lender.

Notice the words the reporter selected, "They bought … invested." They did neither of those things; they borrowed. These people put no money down, borrowed another $50,000, sold for a $190,000 loss, and they are complaining because they might lose $20,000 of their money in taxes. We are not saving an already injured party from further pain, we are removing the only real pain these people will feel.

[schadenfreude alert] The state Franchise Tax Board has received an increasing number of calls from former homeowners who are discovering the giant tax bills they face, said spokeswoman Denise Azimi. Azimi said the former homeowners can work out a payment schedule, though the state charges 4 percent interest on such stretched-out payments.

If the tax is repealed eventually, the taxpayers could seek a refund, but for now, they have to pay what is due by April 15 or face a penalty.

Sen. Lois Wolk, D-Davis … who chairs the Senate Revenue and Taxation Committee, said it was appropriate to group all tax conformance measures into one bill. But if her bill is vetoed again, she indicated she would act to get the cancellation of debt tax repealed.

“We’re certainly not going to allow homeowners to have to pay significantly more tax when they’ve had to relinquish their homes through short-sales (and foreclosures),” Wolk said.

Why not? People who have non-recourse purchase money mortgages are not getting a tax bill. It is only investors, speculators, multiple-property owners, HELOC abusers and others with recourse loans who are getting a break. They are not a group who needs subsidies.


Every borrower will try to establish insolvency as defined by the Internal Revenue Service:

Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities exceeded the FMV of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include:

  • The entire amount of recourse debts, and
  • The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt.

As defined by the IRS, insolvency is a condition of negative net worth; in other words, if you have no assets for the IRS to take, they will leave you alone. True or not, the incentive to feign and declare insolvency is huge.

How many people are filling false tax returns claiming insolvency when in reality, they just don't want to pay, and they hope they can cheat and get away with it?

Irvine Home Address … 4 SWEET RAIN Irvine, CA 92614

Resale Home Price … $629,000

Home Purchase Price … $290,000

Home Purchase Date …. 7/7/1998

Net Gain (Loss) ………. $301,260

Percent Change ………. 116.9%

Annual Appreciation … 6.7%

Cost of Ownership


$629,000 ………. Asking Price

$125,800 ………. 20% Down Conventional

5.06% …………… Mortgage Interest Rate

$503,200 ………. 30-Year Mortgage

$131,132 ………. Income Requirement

$2,720 ………. Monthly Mortgage Payment

$545 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$52 ………. Homeowners Insurance

$137 ………. Homeowners Association Fees


$3,454 ………. Monthly Cash Outlays

-$467 ………. Tax Savings (% of Interest and Property Tax)

-$598 ………. Equity Hidden in Payment

$249 ………. Lost Income to Down Payment (net of taxes)

$79 ………. Maintenance and Replacement Reserves


$2,717 ………. Monthly Cost of Ownership

Cash Acquisition Demands


$6,290 ………. Furnishing and Move In @1%

$6,290 ………. Closing Costs @1%

$5,032 ………… Interest Points

$125,800 ………. Down Payment


$143,412 ………. Total Cash Costs

$41,600 ………… Emergency Cash Reserves


$185,012 ………. Total Savings Needed

Property Details for 4 SWEET RAIN Irvine, CA 92614


3 Beds

2 full 1 part baths Baths

1,567 sq ft Home size

($401 / sq ft)

3,024 sq ft Lot Size

Year Built 1980

5 Days on Market

MLS Number L32256

Single Family, Residential Property Type

Woodbridge Community

Tract Ch


Detached 3 bedroom home in Woodbridge. Steps to South Lake facility. Light and airy ineterior. All white kitchen with breakfast bar for extra seating. Formal livingroom with fireplace. Extra spacious family room with built ins. French doors and window shutters throughout. Mirrored wardrobe doors in the master bedroom. HOA ammeneties include: South Lake, pool, park, tennis, club house, etc…

ineterior? ammeneties?

I like the well-kept neighborhoods with these cottages.

Woodbridge Home 2

Woodbridge Home 4

Woodbridge Home 3

Irvine Housing Blog No Kool Aid

I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.

Have a great weekend,

Irvine Renter

37 thoughts on “California Continues to Tax Forgiven Recourse Debt

  1. HydroCabron

    Aww! Whudda shame!

    Clearly it’s nothing short of communism/fascism/tyranny – or whatever other word these infants wish use for the taxation of free money as income.

    They should do what our Founding Fathers – two capital F’s – would have done in this situation: fly a private plane into an office building and strike a blow for liberty.

    Poor things!

    The schadenfreude – it burns my throat. Aaugh!

  2. tonye

    I guess I’m an idiot and a moron of the worse kind.

    Years ago when I owed the state $27K in taxes over the sale of some assets I bit the bullet and paid it. I also paid the Feds.

    Do you remember all those people who got caught in 2000 when they exercise their options and saw the stock go down the toilet the same year? The all owed zillions of dollars and no one claimed they were victims.

    Why is it that these jerks don’t want to pay. What makes these (the word in my heads is pretty strong) fair for (ditto adjective) politicians to give them a free pass?

    1. Swiller

      They don’t want to pay because they have nothing left. No house, no money left, and probably not a job, but HEY, maybe we can have people like YOU pay for them to be housed in prison like you make ME help PAY for all the harmless marijuana smokers imprisoned.
      I personally think it’s PATRIOTIC to default on a fraud loan that was backed by our government, too bad if that means YOU and I have to pay for it anyway.
      I love it and hope so many people walk from their debt it causes the SYSTEM to collapse. The system is corrupt, and thousands of people were VICTIMS through fraud perpetrated by the corrupt politicians (vote christian republican!!! LMFAO!!)
      and the corrupt banksters.
      I laugh when all you posters cry like a rat eating onions becuase people are defaulting. I hope housing drops another 50% so the whining gets louder and louder…maybe then policies will change.

  3. Planet Reality

    Nice pictures, there is something about that neighborhood and the small cottages that exudes the antithesis of the housing bubble. I like that.

  4. A.W. Chuck

    This is the clincher for me, “who continue to own a previous home and have other assets, their nearly $200,000 in losses does not cancel out their other holdings,” so they CAN pay up.

    They also operate “conservatively” which translates to me that a life of “conservative” investing and avoiding risk (until now) has set them up pretty well. It sounds like they are more irritated by it then wailing bloody murder.

    I picture it went down like this…

    They looked at their nest egg…thought it was a pretty big egg and said to themselves, “Hey…let’s put $545,000 down on red and spin the wheel” and they giggled mischivieously that it wasn’t even their money on the table, winking slyly to each other as the wheel spun excitedly with its drunken get-rich-quick magic.

    Black. Pay up.

    1. IrvineRenter

      I think your description captures the situation very well. At some level they knew they were gambling with the money of others.

    2. Freetrader

      I have no particular problem with what they did — the bank loaned them the money to speculate with after all — but they should pay federal and state taxes on the relief of debt income they have benefited from, full stop. The bank was stupid to loan them money with no collateral, but the least they can do is pay the tax on the income.

      BTW, “Love is Like Oxygen” — great stuff — summer of 1978.

      1. A.W. Chuck

        Agreed. I’d say it’s more than the “least they can do” though. Banks can make bad loans to speculators all day long, eventually they’ll have to shut their doors. Such is private business.

        But if this couple and others like them escape the tax consequences of speculation, then you and I have to pick up the slack in that missing tax revenue…and I know we didn’t approve their speculative loan, so I don’t think we should pay for it.

  5. Why Me?

    Yesterday post and today post have example of seniors 70+ and today’s 63+ y.o.. Yesterday’s senior likely knows that the bank is unlikely to kick out a senior — very bad press and courts naturally lean for the seniors. They need to really tick off a legit bank to get kicked out when putting up a fight. loan sharks are another matter.
    Today’s seniors took a short sale and are out free rent less taxes. So much for tax advice from this professional tax preparer.
    For normal working stiffs, it’s cough up the money or go to jail.

    The house looks like a $15,000 house back in the early 1960’s, that would be 2 or 3 years wages for the typical CA worker.

    1. IrvineRenter

      I didn’t pick up on the senior angle until you pointed it out. The reporters found seniors for this article when they could have found people from every age and demographic. Seniors are not alone in gaming the system and facing huge tax bills. Are seniors being selected for effect by the reporters? Are seniors more willing to talk than other ages or demographics?

      1. Misstrial

        I’m thinking that boomers form the largest deadbeat pool.

        They are more willing to talk because introspection, communication, entitlement, a strong belief in social services and legal-loophole absolution are among the descriptors/attributes of that age-group.

        1. newbie2008

          Seniors and single mothers are the new angles for the media and hacks. Young orphans would be better if they could legally sign the loan contracts.

  6. wheresthebeef

    I do not have one ounce of sympathy for these folks. What they did was nothing short of taking 545K of borrowed money to the casino and they made some bad bets and ended up losing almost 200K of the borrowed money. Now they are screaming bloody murder that they are taxed 10% on their gambling losses, even if their debts are passed on to someone else. Something tells me that this scheme wouldn’t work in Vegas. Eff these people.

    They even admit to wanting to pad their retirement accounts from the profits of this second house. And then they have the gall to say “if we have to pay, then we’ll pay it.” PAY UP YOU GREEDY DEADBEATS. They are lucky they aren’t on the hook for the rest of their losses. People like this were prime reasons for the run up in house prices. And they probably prevented a family who was more financially deserving of owning that house.

    A tax preparer…good god!

  7. scott

    Since this doesn’t appear to be a non-recourse purchase money mortgage, why was the lender so willing to allow a short sale (which in general don’t seem easy to get)? I assume this wasn’t a non-recourse purchase money mortgage (the article indicates that if that was the case there is no tax liability) and it seems these people have other assets. Now I also get there is cost in getting a judgement and a borrower can threaten to drag out the process to make it uneconomic which is why, in many cases, these things get negotiated with the lender (I’ll pay you half the deficiency to walk away). The full story of their short sell isn’t in the article but I’d be annoyed if they got off scott-free.

    I also like the line about only reason they bought a house was to ‘pad their retirement account’. No wonder we got into this mess…

  8. jimfromJaxFla

    looks like it will take SOME TIME to purge this from our bloodstream…
    reinstate Glass-Steagall…

  9. Gemina13

    Oh, good Lord. Yet more crybabies whimpering that they’re owed a break simply because they played the Bubble Lotto and lost. Looks like the Schadenfreude isn’t gone at all.

  10. avobserver

    Let’s all hope Schwarzenegger will hold the ground and veto the sh** out of this. How long do we as a society have to continue to bail out people who made greedy but foolish decisions – until we turn everybody into fools and the word “foolish” is no longer needed in an English dictionary?

    It has become a recurring theme since the end of housing bubble two years ago. Here is a quick analogy: let’s say you were standing in a casino watching a bunch of people playing blackjack. You saw this guy drew a 2, then a 4, then for inexplicable reasons he decided to go all in with all the chips he had, plus his wallet, watch and car key. Just when you began to laugh at the stupidity of the guy – right in the middle of game, the casino announced that effective immediately they changed the rule of play from the game of “21” to game of “6”.

    Welcome to the new reality of casino economy. Our winner in the story could be the cousin of the casino owner (or used to work at a place called Goldman Sachs), or he was just lucky, pure and simple. I remember someone commented yesterday that the difference between an investor and a gambler is knowledge and information (and analytical skills I may add). Of course our brand of capitalism is built on calculated risk taking based on knowledge and info. But the underlying assumption has always been that the rules of the game remain relatively the same. You don’t shift the goal post every five seconds. If the rules of the game with regard to reward/penalty get changed constantly DURING the game, how can anyone (with the exception of insiders) gain any edge? If one uses all his/her game knowledge, analytical prowess and steely stomach to develop a bullet proof strategy for blackjack, only to find out right in the middle of a game – after he already placed the bet, the aim of the game is no longer to hit 21?

    As long as our society keeps rewarding foolish behaviors and penalizing real investors (who base their decisions on rational thought process) thru this kind of outrageous manipulation by the “House”, no one will be able to escape this ultimate trap of fate.

    1. lowrydr310

      Even better than changing the rules of the game, in our casino economy you can lose a bet and not have to pay! (B A I L O U T)

      Imagine having the opportunity to play roulette knowing that your losing bets get handed back to you, and you get to keep all the winnings. Or how about a slot machine with unlimited pulls, and when you win hit it big you can cash out and redeem your ticket?

      1. avobserver

        Lose a bet but not have to pay is definitely one of the new rules … what else … If you lose a bet big enough the House will lend you unlimited amount of dough at zero rate to loan out to others and collect a nice spread to recover your loss?

    2. IWantMineToo

      For all the people that didn’t get themselves into this mess and wouldn’t get a bailout we should get the equivalent amount as a check to us as these people would get forgiven.

      Make it equal right.

      These kind of people piss me off.

  11. Soylent Green Is People

    Quite a story in the OCR on Cali’s clawback on SS debt forgiveness. Many of the Realtor communities “SS Specialists” neglect to pair their prey (victims) with a qualified CPA and or BK attorney to find the proper pathway out of their current morass. One wonders if you can sue the Listing Agent for malpractice if financial advice was given. I know brokers carry heavy Errors and Omission insurance. Don’t know if any saavy lawyer has decided to dive into that pool of opportunity yet. I’m going to grab some popcorn and watch from the sidelines when that fight gets started.

    My .02c

    Soylent Green Is People.

    1. avobserver

      That would be quite a spectacle. Although I do hate to see those “savvy” lawyers milk more money out of this mess.

      BTW, watched the movie last night. Thanks for the spoiler. 🙂

      1. Soylent Green Is People

        A society and environment in collapse. The rich surviving on what cream still exists while the poor eat their young.

        Not much has changed since Chuck Heston came to realize just what he’s been surviving on for the past few years. The death scene with Edward G is great.

        My .02c


        1. newbie2008

          As in the movie, the people just continued to chow down after hearing that Soylent Green is people. Another round of near nothing down with FHA’s 3.5% down with good credit and 10% down with subprime borrowers.

          Stock market rally with 0.2% loans to the banksters that were to lean the money to business to keep people working. Instead they buy stock or merger companies to layoff more people. Will there be any manufactures left in America or only holding companies?

        2. avobserver

          Yes SG is a great film that says more about the future of our society than all the movies made in 2009 combined, instantly joins Blade Runner as one of my all time favorites in this genre. Not too crazy about Heston’s NRA agenda but his acting in this one is superb.

  12. lowrydr310

    Why does the state collect tax on forgiven debt?

    The couple is helped by not having the obligation to pay their loan, however they’re not exactly making out like bandits with a ton of cash in their hands.

    Suppose the couple continued to pay the mortgage for 30 years – would the state be collecting any tax revenue on this money?

    OR is this supposed to compensate for the state taxes that would normally be collected by the banks’ profit (and since the bank is writing off a big loss, they won’t likely be paying much if any income tax)? What if the lender is based outside of California? Assuming the borrower pays the mortgage off in 30 years, the state wouldn’t be collecting any tax from this transaction.

    1. HydroCabron

      They borrowed the money and spent it on home improvements, consumer goods, or other properties. When they borrowed the money, it was not income, because it was a loan that they must pay back.

      Now that they won’t be paying the money back, it turns out that it was income. It doesn’t matter what they blew it on: they received money, which is income.

      If I work for money to buy a big-screen television, or to invest in real estate, I am taxed on that money, even if television wears out or the real estate investment takes a dump. Why should people who did nothing more than sign a paper to get that money be treated differently?

      1. avobserver

        yep. any money you get without having to pay it back by definition is income. that’s why forgiven debt is income. whether you blow the money on over-priced house or burn it up in the fireplace is beside the point.

    2. Crug

      Yeah if forgiven debt was never taxed, I would ask to be paid by a company “with a loan” and have the loan discharged later. That way, I get a tax free check in the end.

      At least, this is how the rationale of the law was explained to me.

  13. quailoverthehill

    I always loved these Cottage Homes, until I got inside one and went upstairs. The “master” bedroom has no walk-in closet and the bath has only a stall shower; no tub. Considering that these places had $700K asking prices four years ago, you’d think you wouldn’t have to go down the hall to your kids’ bathroom to take a bath.

  14. nobody

    Income is “all income from whatever source derived.” Debt forgiveness is income because you no longer have to pay your obligations back. If you borrow money, you now have cash, but in exchange you give a note (contract) to the lender promising to pay. In theory that note is worth the amount that you borrowed (adjusted for interest). This means that your net worth (assets-liabilities) has not changed because although you have X more cash, you have an obligation to pay X+interest back to the bank.

    If the lender relieves you of this debt, you now have the cash but no obligation to repay. This means you have income and your net worth has increased. How much income did you have? The value of the note subtracted what you had paid – the amount “forgiven.”

  15. newbie2008

    I will be happy to take a million dollar loan and have that debt forgiven by the bank. If you have a million dollars to loan me and forgive the loan, I will be more than willing to pay CA’s 11% tax on the million. But please have Uncle Sam forgo the federal tax or I’ll cry to my congressman.

  16. Chris

    “Why not? People who have non-recourse purchase money mortgages are not getting a tax bill. It is only investors, speculators, multiple-property owners, HELOC abusers and others with recourse loans who are getting a break. They are not a group who needs subsidies.”

    I would add one more group of folks that fits into this category: those that can’t afford to buy but stretched themselves beyond what they can afford.

  17. awgee

    Consider the following:

    The Jones bought a home in Irvine in 1980 for $100,000. The Jones start borrowing on their home in 2000 and refi and HELOC until they owe $1,200,000 on their home in 2007. These are not unrealistic numbers and IR and all of you can find examples like this. The Jones can not make their payments in 2009, discover that their home is worth $900,000 in 2009 and decide to short sell their home. Escrow closes at the end of 2009 with a short sale for $900.000. What are the tax implications?
    There is probably no tax on the $300,000 for given debt.
    There is a $500,000 exemption on the cap gains from the sale of a personal residence.
    But, the Jones still have a tax liability on the remaining $300,000 of cap gains. And no equity. Ouch!

    1. newbie2008

      the Jones may not technically have equity, but the Jones should have $1,100,000 cash for the loan. If they sell for 900,000 on a short sale, they should have $1,100,000 in profit instead of the 800,000 profit without the bank subsidized short sale. I would be glad to be in the Jones financial situation and pay the tax on the $300,000 cap gains ($50,000 plus state tax) with the $1,100,000 cash in hand. The $1,100,000 cash can still buy a nice house or the Jones can rent for a life time with the $1,100,000 cash

      Your tax dollars hard at work. Nice to see someone other than a bankster get a break. But likely Mr. Jones is also a bankster. Reminds me of the TRigde FC’ed house that I looked at. Bankster took out only $600,000 and lived rent free for a year. A Newport beacher took out $1,600,000 but I don’t know his profession.

      1. awgee

        There are many folks in the position like the example of the Jones and none of them have any cash, $1,000,000 or even $100,000. They took out the equity in increments every so often and spent it as income. None of them ever would have done so had they known their ultimate financial destination. I am telling anyone to feel sorry for them or excusing irresponsible personal financial behavior. I am not saying they should or should not have a tax liability. I am just pointing out the way it is for many.

        Interestingly, many are now living in their homes rent and mortgage free as the trustee sales are postponed over and over again, and there will be no tax liability incurred on free rent.

Comments are closed.