04.24.10
Posted in Real Estate Law, Taxation Law at 09:56 by Administrator
Under federal tax law, all income is subject to taxation, unless specifically exempted. Debt which a lender forgives or cancels – commonly referred to as cancellation of debt (COD) income – is considered to be income to the borrower and, thus, generally is subject to federal taxation. Current federal law provides for a temporary exemption for taxation of COD.
On April 13, 2010, California enacted state Senate Bill 401, which brings California state law concerning COD income substantially in accord with current federal law. Pursuant to SB 401, distressed homeowners will no longer have to pay California state income tax on debt forgiven in a short sale, foreclosure, or loan modification. For debt forgiven on a loan secured by a “qualified principal residence,” borrowers will now be exempt from both federal and state income tax consequences. The existing federal exemption is for indebtedness up to $2 million, whereas the new California exemption is for indebtedness up to $800,000 and forgiven debt up to $500,000.
“Qualified principal residence” indebtedness is defined as debt incurred in acquiring, constructing, or substantially improving a principal residence. It includes both first and second trust deeds. It also includes a refinance loan to the extent the funds were used to payoff a previous loan that would have qualified.
The California exemption applies to debts discharged from 2009 through 2012. Californians who have already filed their 2009 tax returns may claim the exemption by filing a Form 540X amendment.
Taxpayers who do not qualify for the above exemptions (e.g., second home or rental property) may nevertheless be exempt under other provisions. Most notably, taxpayers who are bankrupt are exempt from debt relief income tax. Also, taxpayers who are insolvent are exempt from debt relief income tax to the extent their current liabilities exceed current assets.
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04.16.10
Posted in Litigation, Real Estate Law at 18:44 by Administrator
It has been argued that the American legal system unduly promotes and encourages a litigious society, with California often cited as evidence for the validity of this argument. Other states, in turn, often consult – and frequently follow – California legal precedent when addressing for themselves legal issues which California has previously considered. For this reason, it is important for real estate investors – whether they invest in California or other states – to be aware of the conflicting and sometimes inconsistent rulings by California courts on the issue of whether to recognize or disregard the asset protection qualities of business entities used to hold real estate assets.
Long before Limited Liability Companies (LLC’s) and other legal entities were commonly used to hold real estate for the purpose of asset protection, the “alter ego” legal doctrine arose in the law to “pierce the corporate veil” in cases where the “corporate-separateness” of legal entities had been used to commit fraud or to otherwise shield an entity’s owners from the entity’s violation of law. When a court uses the alter ego doctrine to pierce a corporate veil, the legal protections of an LLC or other legal entity are disregarded and the owners of real property held by the entity are treated as individuals for the purpose of civil litigation.
In addition to using the alter ego doctrine to pierce the corporate veil in cases where the owners of an LLC or other entity have committed fraud – which constitutes a legitimate and uncontroversial use of the doctrine – several California courts have applied the doctrine to cases where no law was violated nor fraud committed. The justification courts have given for this expansion of the doctrine is that invoking the court’s “equitable” powers as a means to apply the doctrine is necessary to prevent an “unfair” result.
In one such case, Mesler v. Bragg Management Co., 39 Cal.3d 290, 300-301 (1985), the California Supreme Court held that a group of affiliated real estate entities that were technically exempt from a local rent control ordinance because each entity held title to four rental units or less, could nonetheless be treated as a single entity for purposes of the rent control ordinance. The court found no evidence of fraud or bad faith on the part of the defendant entities or their managers, and the defendants produced an expert declaration stating that the use of separate entities to own individual properties is exceedingly common in the real estate industry. In justifying this result, the court said that even though “there are legitimate purposes for the way Defendants are organized does not preclude a finding that with respect to the [rent control ordinance] it would be inequitable to recognize Defendants’ separate existence. Id, at 300-301.
By disregarding the legal distinctions between the entities and their owners, the court in Mesler effectively substituted its notion of “fairness” for the law as enacted by the California legislature.
Judicial change in the law, like many other types of change, is usually incremental and gradual. Given recent trends in the law, it seems more likely than not that California courts will continue to decide cases based on what lawyers in black robes consider “fair” and “unfair”, rather than on the actual text of laws. Thus, it is entirely foreseeable that many California courts will further expand the use of the alter ego doctrine, so as to apply the doctrine in new, different, and more far-reaching contexts.
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