California Attorney General Kamala Harris in 2012 reached a landmark deal with the three largest U.S. housing lenders, under which the lenders agreed to provide $12 billion in relief to homeowners in the state with underwater mortgages. Last fall, the monitor appointed to supervise the deal reported that the $12 billion agreement grew to "an $18 billion achievement," half in principal reductions for those who stayed in their homes and half in short sales for those who wanted to get out.
While Harris has called the deal a major achievement, there is another side to the situation, according to Dan Walters of the Sacramento Bee. The $9.2 billion in principal reductions is considered income to those who received them. This amounts to an average of $137,281 for first mortgages in the settlement and $91,261 for second mortgages. Homeowners who received the reductions could have significant state income-tax bills for 2013 as a result of the forgiven debt.
Congress exempted principal reductions from federal taxation. However, a temporary exemption for California expired at the end of 2012, and the Legislature failed to act last year on an extension. A tax exemption could not take effect unless Senate Bill 391 became law. The legislation is "languishing" in the California Assembly, Walters writes, and unless an tax exemption is enacted quickly, tens of thousands of filers must pay state taxes on mortgage write-downs. The California Bankers Association also has sponsored a new bill to retroactively reinstate the tax exemption.