How Does a "deed-in-Lieu" Affect Your Taxes in California?

Homeowners in California may have to pay deed tax and/or capital gains tax in a financial situation involving a deed in lieu of foreclosure, according to the Law Office of Linda C. Garrett. Homeowners may be able to use various state mortgage relief acts to obviate income taxes on canceled debt.

A deed in lieu involves a transfer of real property from the debtor to the financial institution that owns the property, meaning that California's deed tax may come into play for the borrower, notes Garrett. If the value of the property upon transfer is greater than that of the original purchase price, the homeowner may have to pay capital gains tax.

Another tax consideration involves cancellation of debt income, otherwise known as forgiveness of debt income, says the California Association of Realtors. If the debt is a recourse debt, meaning the homeowner received taxable income for the amount of the debt forgiven, that person may owe taxes to the state. For nonrecourse debt, this tax does not apply.

A deed in lieu of foreclosure transfers the title of real property back to the lender without a foreclosure or trustee sale, notes Garrett. This type of agreement may allow homeowners a tax break should the lender agree not to file a 1099 form with the Internal Revenue Service. This tax filing translates as a loss to the lender and income to the buyer, and the borrow owes taxes on that income.