Sacramento –A new state law allows taxpayers to immediately exclude from their income the amount of mortgage debt on their home loan that has been forgiven by their lender. The law largely brings California statutes into conformity with current federal law. Previously, California conformed to federal debt relief only for 2007 and 2008, according to the Franchise Tax Board (FTB).

“California has been particularly hard hit by the housing crisis,” said State Controller and FTB Chair John Chiang. “This is a critical tax change that will help people in our state who already are suffering the loss of their homes.”

The new law, SB 401 (Wolk), allows most taxpayers to exclude canceled mortgage debt income of up to $500,000 on their principal residence. The limit is $250,000 for married/registered domestic partner (RDP) individuals filing separately. It applies to debt forgiveness in 2009 through 2012 resulting from a foreclosure, “short sale,” or loan modification of a taxpayer’s qualified personal residence.

Prior to the law’s passage, these amounts were taxable to California. If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount often is taxable. These amounts are generally reported on a 1099-C and are provided to both the taxpayer and the government. Debt forgiveness on other types of debt, such as a second home or business property, does not qualify for exclusion under the new law.

The law largely brings California into conformity with the federal Mortgage Forgiveness Debt Relief Act for discharges that occurred in tax years 2007 through 2012. However, California’s limits of qualifying principal residence indebtedness differ from federal limits.

Qualifying taxpayers who have already filed their 2009 tax returns should file Form 540X, Amended Individual Income Tax Return, to subtract the amount of debt relief from income. To expedite processing, write “Mortgage Debt Relief” in red across the top of the amended tax return. Taxpayers must attach a copy of their federal return, including Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), with their state tax return.

Like federal law, the new state law allows individuals and businesses to exempt energy grants that are provided in lieu of federal energy credits from their gross income and alternative minimum taxable income. It also conforms California law to many other federal provisions.

According to FTB estimates, approximately 100,000 people may benefit from mortgage debt relief for tax years 2009-2012. For more information, taxpayers are urged to visit FTB’s website at www.ftb.ca.gov.