While the federal tax law carved out an exception to the tax on cancellation of debt income when it involved the taxpayer’s home, the state of California did not move to conform its tax law to federal law. Those who lost their homes to foreclosure faced state taxes on the phantom income.
California conformed its law to the federal treatment of forgiveness of debt income this week. At least California has moved away from kicking taxpayers when they are now.
Now if someone would enact an effective, balanced approach to mortgage modification that considers principal reduction. Otherwise, I continue to advise clients to walk away from houses they will never be able to sell for enough to pay the mortgage.