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I have a question for a CPA about a specific California tax

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Hello. I have a question...
Hello. I have a question for a CPA about a specific California tax issue related to debt forgiveness. Is this something you can help with?
JA: The Accountant will know how to help. Please tell me more, so we can help you best.
Customer: In California, is debt forgiveness on a second mortgage taxable as income **if** the second mortgage was used only as purchase money for the original purchase of the home?
JA: Is there anything else the Accountant should be aware of?
Customer: The house was foreclosed on, so I think the second mortgage -- since it was entirely used for purchase money -- is non-recourse. Is that correct?
Submitted: 6 months ago.Category: Finance
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Customer reply replied 6 months ago
More details here: Thanks to a class action settlement by State of CA, we were offered an OPTIONAL second-mortgage debt forgiveness by our bank. We could have refused the offer, as we were in the middle of a strategic default (which our CPA was fully aware of.) We asked our CPA whether to accept the offer, or refuse and let the second go to foreclosure, as the entirety of the second mortgage was used for the **original purchase**, and thus NON-RECOURSE. She told us to accept, but only after a long delay (she had a well-documented pattern of unresponsiveness). She likely should have known that the state would consider this income, and tax accordingly. She also DID know that the second mortgage was purchase-money, for which we would not be liable after the house went to foreclosure. Was she negligent?
Answered in 31 minutes by:
5/9/2017
Financial Professional: Matthew Breecher, Certified Public Accountant (CPA) replied 6 months ago
Matthew Breecher
Matthew Breecher, Certified Public Accountant (CPA)
Category: Finance
Satisfied Customers: 286
Experience: Director of Advisory & Assurance
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Financial Professional: Matthew Breecher, Certified Public Accountant (CPA) replied 6 months ago

In short, generally all forgiven debt is taxable income. However, this does not apply to a non-recourse loan. I cannot say if the second mortgage was non-recourse as a purchase-money note could be both. But, you state that you "would not be liable after the house went to foreclosure". If that is the case, that you were not liable, then it sounds like you are correct that it is a non-recourse loan.

...

To clarify the definition, so we are on the same page; a non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral.That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.

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Customer reply replied 6 months ago
Hi Matthew, thank you for the reply. I'm confused when you say: "Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income." Because the second-mortgage was used entirely for the purchase, (and is thus non-recourse), how could there be any debt income to report?I suppose the real question is: if the non-recourse, purchase-money second-mortgage had still been in place when the house was foreclosed upon, would the amount of the second mortgage ($90K) have counted as personal income for tax purposes in that year?
Financial Professional: Matthew Breecher, Certified Public Accountant (CPA) replied 6 months ago

To clarify, just because the second mortgage was used for purchase of the house does not make it non-recourse. What makes it non-recourse is the contract wording itself. Therefore, if it was non-recourse as defined in the contract, and the house was foreclosed, there is NO cancellation of debt. So, to answer your question, if this was in fact a non-recourse loan (as defined in the contract), then the second mortgage is NOT taxable as personal income.

...

I hope that is more clear. If not I would be happy to expand and reword my response with more clarity.

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Customer reply replied 6 months ago
Thank you for clarifying. That is what I needed to know. Take care!
Financial Professional: Matthew Breecher, Certified Public Accountant (CPA) replied 6 months ago

I hope I answered your question with sufficient detail, accuracy, and completeness based on the facts communicated. I would be happy to expand my answer should you need clarification; before you rate my answer. Accordingly, please rate my answer, based on thoroughness and accuracy, rather than any good or bad news/content. We (the experts) are only compensated when an answer is accepted and rated. I appreciate your prompt response. Sincerely, ***** ***** Breecher, CPA.

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Financial Professional: Matthew Breecher, Certified Public Accountant (CPA) replied 6 months ago

I wanted to follow up and see if you need further information. If I have provided you with a sufficient response, please rate my answer as we are only compensated for our time of we receive a 3 to 5 star rating. I would be happy to expand on my response as your satisfaction and a 5 star rating is my goal.

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