In response to a letter Senator Boxer sent to the Internal Revenue Service (the “Service”) last year, requesting clarification as to whether a short sale conducted pursuant to California Code of Civil Procedure (“CCP”) §580e resulted in cancellation of indebtedness (“COI”) income, the Service issued Information Letter Number 2013-0036 (“ILN 2013-0036”). ILN 2013-0036 states, “We believe that a homeowner’s obligation under the anti-deficiency provision of section 580e of the CCP would be a nonrecourse obligation to the extent that, for federal income tax purposes, the homeowner will not have cancellation of indebtedness income. Instead, the homeowner must include the full amount of the nonrecourse indebtedness in amount realized.”
On April 29, 2014, the Service issued a clarification of ILN 2013-0036 (“4/29 Clarification”) which stated that they had been overly broad in, “… extending our analysis of the federal tax treatment of obligations beyond those [purchase money obligations] described in section 580b(a)(3).”
The authors believe that the position the Service took in ILN 2013-0036 is supported by a plethora of cases following Crane and Tufts which distinguish recourse from nonrecourse debt based on whether the debtor is subject to a deficiency judgment at the time the debt is discharged.
The authors further believe that the position adopted in ILN 2013-0036 should not be limited to short sales conducted pursuant to CCP §580e. Rather, ILN 2013-0036’s analysis should be extended to other anti-deficiency statutes and “reinforced” by issuance of some sort of “substantial authority” concluding that, to the extent an anti-deficiency statute eliminates a debtor’s personal liability with respect to a debt following the disposition of any collateral securing that debt, the debt should be treated as nonrecourse at the time of the disposition which triggers application of the anti-deficiency statute.
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