Phantom Income

• If all or part of a mortgage or refinace was forgiven, that amount was considered phantom income.Jupiterimages/Comstock/Getty Images
  
  Take the example of a California homeowner who took out a mortgage on a house in 2005 for $300,000 and then lost his job in 2007, leaving him unable to afford the payments. He could either sell his house to pay off the mortgage or the home would be foreclosed upon by the bank. In 2007, the value of the homeowner's house fell to $175,000. If he had a short-sale, selling the house for $175,000 dollars, he would still owe the bank the difference, or $125,000 dollars. If the bank chose to forgive the short-fall and allow the homeowner to walk away from the debt, the government treats that as a taxable event, as if the homeowner received $125,000 in income. This is what came to be called "phantom income." Until California adopted the state Mortgage Forgiveness Debt Relief Act, homeowners in this situation still had to report the short-fall as income on their state tax return, even though it was exempt on their federal tax return.
  
  

Eligibility

• The California law was amended in 2010 to include 2009 through 2012.Medioimages/Photodisc/Photodisc/Getty Images
  
  Although enacted in 2009, the original California Mortgage Forgiveness Debt Relief Act allowed taxpayers to re-file under the new rules for 2007 and 2008. However, it was amended on April 12, 2010, to conform to the federal law covering short-fall mortgage debt forgiveness from 2007 through 2012. After 2012, any amount forgiven by a lender on a mortgage will once again be taxable as income to the taxpayer.
  
  

Types of Mortgages

• Not all mortgages are eligible.Comstock Images/Comstock/Getty Images
  
  Only mortgages taken out to buy a home or make home improvements are eligible. If a homeowner refinanced his house and used the money to pay for his daughter to go to college, his refinance would not be eligible under the act. It is important to consult a tax professional for information as to whether you qualify.
  
  

Limits

• California limits the amount of qualified residence indebtedness to $800,000 for married or registered domestic partners filing jointly, and those filing as single, head of household, widows or widowers. The limit is $400,000 for married couples or registered domestic partners filing separately. The amount of debt relief is limited to $500,000 for single, head of household, widows/widowers and married taxpayers filing jointly and $250,000 for married couples or domestic partners filing separately. The act is limited to primary residences only; it does not apply to second homes or businesses.