The IRS has clarified in a letter that California’s troubled homeowners who sell their homes in a short sale are not subject to federal income tax liability on “phantom income” they never received.  The IRS recognizes that the debt written off in a short sale does not constitute recourse debt under California law, and thus does not create so-called “cancellation of debt” income to the underwater home seller for federal income tax purposes.  This clarification rescues tens of thousands of distressed home sellers from personal liability upon expiration of the Mortgage Forgiveness Debt Relief Act of 2007 on Dec. 31, 2013

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