California won't tax forgiven home debt

In a statement Monday, Govenor Schwarzenegger said, "It is important that we continue to provide all possible assistance to homeowners who were negatively impacted by the mortgage crisis…and protect them from thousands of dollars in unfair taxes."

Those affected can now rest a little easier, knowing they won't be hit with a large state tax bill after already being forced to sell their home at a huge loss.

Mortgage debt is typically considered forgiven by lenders – and eligible for taxation as extra income – during a foreclosure or a short sale. In short sales, lenders accept a price below what's owed to avoid higher costs of foreclosing. The difference is the forgiven debt.

The state Franchise Tax Board estimates about 100,000 Californians will be spared from $34 million in state taxes through 2012 as a result of the new law.

The tax relief plan applies only to people who lost homes in which they lived. Investors are not affected and still owe, says the FTB.

State officials say qualified taxpayers don't have to do anything to get the tax break. Those who qualify for federal relief will automatically get the state relief.