Hello JA Guest,
It looks as though from your post that you are a resident of the state of CA. If that is the case, CA does not honor the same exemption on the exclusion of debt from a short sale or foreclosure as the IRS does.
The only way to exclude the debt from CA taxes is if you can show that you were insolvent at the time the debt cancellation occurred. Proving insolvency means you must be able to show that your liabilities exceeded the total value of your assets. If you think you would qualify under the insolvency rules, you would file Form 982 with your federal tax return and attach the worksheet they provide to show how you arrived at your insolvency status.
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Thank you JA Guest
Hello again JA Guest,
I realize that form 982 is part of the IRS forms. But since the state of CA does not honor the same exclusion on debt canceled on your primary residence as the IRS does, the only way you can exclude this from your CA taxable income is if instead of claiming the automatic exclusion, you instead file for exclusion under the insolvency rules. You would need to do this for both your federal and state returns in order for this to apply in the state of CA.
If you had settlement money from the divorce which would make it impossible for you to show insolvency, then you may have no choice but to pay CA state taxes on this canceled debt.
I am sorry I could not give you an answer with a better outcome, but unfortunately CA does not honor the exemption allowed by the IRS on debt canceled on your primary home, which is why Turbo Tax is including that as part of your state taxable income.
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