Did you know that forgiven mortgage debt could be subject to taxes? Prior to 2007, any forgiven debt was treated as regular income. In 2007, the Mortgage Forgiveness Debt Relief Act was passed in order to give people a reprieve from taxes on forgiven mortgage debt. The Act is scheduled to expire at the end of the year. This could be a big problem for plans to increase debt forgiveness under the new proposed mortgage settlement.
I learned of this from an article on ProPublica by Lois Beckett as well as an article by syndicated Real Estate columnist Kenneth Harney. According to the Harney article, an extension for the Mortgage Forgiveness Act will have difficulty passing through Congress.
The reason this is a big deal is because of the terms of the proposed mortgage settlement. The settlement, which has not been finalized, may require banks to allow $10-20 billion worth of principal forgiveness, short sales, and other relief (I hate the proposed settlement – and this number is unconscionably small – but that is an issue for another blog). Let’s say you have a house that due to declining property values is worth $300,000 but you owe $400,000 on the mortgage. Under some circumstances, the bank may allow you to sell the house for $300,000 and forgive the additional $100,000 you owe on the mortgage. Under current tax laws, there is no tax on the $100,000 that was forgiven. If the Mortgage Forgiveness Debt Relief Act is allowed to expire, the $100,000 would be taxed as additional income.
So already distressed home owners could be trading mortgage debt for tax debt. While the tax debt would be less than the mortgage debt, this could still be an onerous burden and could put a damper on any relief offered by the mortgage settlement.
It generally takes a long time to conduct a short sale, and it takes a long time to work out a principal modification. Given that the mortgage settlement has not even been finalized, it could be months until relief is offered to homeowners, and it may take months after that to work out the particulars. By this time it may be too late for many people.
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