If you are a California resident you may know by now that California does not fully comply with the Federal Government's law with respect to the Mortgage Forgiveness Debt Relief Act of 2007. Under Federal Law up to $2 Million of cancelled debt from Qualified Mortgage Indebtedness on a principal residence is excluded from income.

For taxable years beginning on or after January 1, 2009, California conforms to this law with the following major exceptions:

  • Qualified principal residence indebtedness is limited to $800,000 ($400,000 if married filing separately), rather than the more generous amount of $2,000,000 provided by the Feds.
  • The maximum Cancellation of Debt exclusion is further limited to $500,000 ($250,000 if married filing separately).

This could very well mean that a taxpayer in California could have cancellation of debt income fully excluded for Federal income tax purposes and owe a substantial sum in taxes to the State of California. Therefore, California taxpayers must be aware of these important differences in conformity to the Federal law if they have a transaction they are contemplating that involves the cancellation of debt on a principal residence so that there are no surprises.