WASHINGTON -- Given the huge public and private resources being devoted to helping financially distressed homeowners -- including the recently announced $25 billion national mortgage settlement with five major banks -- a key federal tax law benefit underpinning these efforts might be assumed to be a shoo-in for renewal.
But it's not. The Mortgage Forgiveness Debt Relief Act is to expire in 10 months, and there are indications on Capitol Hill that it might be allowed to die. The law, enacted in 2007, allows homeowners who have received reductions in the principal of their mortgages as the result of loan modifications, short sales, or foreclosures to avoid income taxation on the amounts forgiven.
Loss of that tax help would endanger huge numbers of distressed mortgage arrangements. For example, the $25 billion mortgage settlement with 50 state attorneys general requires the banks to provide more than $10 billion in principal reductions to borrowers. Other lenders and mortgage servicers who are not parties to the settlement already provide principal reductions to troubled borrowers. Many of these owners would face hefty and ill-timed taxable-income hits if the law is not extended.
Douglas Holtz-Eakin, president of the center-right American Action Forum, former director of the Congressional Budget Office, and economic adviser to Sen. John McCain's 2008 presidential campaign, said in an interview that there is "a powerful sentiment," especially among conservative freshman House members supported by the Tea Party, that tax code "bailouts" to delinquent and underwater homeowners are unfair.
Prior to 2007, all cancellations of debt by creditors -- whether on auto loans, personal loans, or mortgages -- were treated as taxable events under the federal tax code. If someone owed $200,000 but paid off only $150,000 through an agreement with the lender, the $50,000 difference would be ordinary income, taxable at regular rates.
Under the debt relief law, qualified homeowners can avoid taxation on forgiven mortgage amounts up to $2 million (married filing jointly) or $1 million for single filers.
To be eligible, the debt must be canceled by a lender in connection with a mortgage restructuring, short sale, deed-in-lieu of foreclosure, or foreclosure. The transaction must be completed no later than Dec. 31.
That impending deadline and the risk that Congress won't reauthorize the law in time have real-estate professionals and tax planners on edge.
"This is serious," said Harrison Long, a broker in Irvine, Calif. "Anybody thinking about doing a short sale this year needs to get moving on it now," given the long timelines needed to complete such transactions -- often from four to 12 months.