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Congress Needs to Extend the Mortgage Debt Relief Act

MAR 13, 2012 11:07am ET
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When faced with a national issue like the housing crisis, there are times we need to put aside the arguments about who to blame and who should bear the cost so that we can focus on an immediate issue that must be addressed soon in order to help maintain the recovery from the negative impacts the crisis has imparted on all participants. We are now at such a moment.

Underwater homeowners tend to get information from many sources, and, unfortunately, the information received isn't always consistent or accurate. Oftentimes, information about the laws in one state is not applicable to borrowers in another.

Lenders, Realtors and friends alike all have their own agendas regarding how borrowers should perform and behave, and there is no shortage of writings setting forth such expectations.

However, an issue of critical importance is gaining the attention of savvy underwater homeowners, and there can have only one answer regarding what needs to be done. The Mortgage Forgiveness Debt Relief Act is scheduled to expire on Dec. 31, 2012, and, absent any discussion of extending this law coming from Capitol Hill very soon, the pending sunset of the act will cause some chaos in what is starting to be perceived as a recovering residential real estate market.

The act states that forgiveness of debt used to purchase or improve a borrower's principal residence will not be considered taxable income.

The act has provided dramatic comfort to many underwater homeowners who feared that while they were working through their issues with their lender, the IRS was waiting in the wings to collect. But now there is concern that the IRS will be in a position to start collecting. Unlike the payroll tax, where Congress could wait until the eve of its expiration, the timelines needed to short sell a home (at least three months and certainly longer if demand is lacking) mandates any extension of the act be addressed immediately.

Absent such action, a surge in homeowners anxious to short sell their home (and likely simultaneously stop making payments since even foreclosure, with its added negative repercussions, could result in a significant tax savings) is going to put downward pressure on housing values. Supply will outpace demand. Recent reports that average housing price declines slowing will undermined.

Why are homeowners so gravely concerned that Congress will not act in time? Beyond the gridlock we have all witnessed, I asked an aide to a U.S. senator who was about to meet with. The aide said that he (the senator) was aware of the issue, but that he (the aide) didn't believe Congress would act until after the November elections. I responded that it will be too late. Congress must not put its head in the sand; it needs to take action to extend the act now.

But another mere multiyear extension (as have been previously achieved) is just not enough. This is not because I'm concerned the housing crisis will last more than another few years.

My concern flows from the fact that prior to the end of the housing crisis, hopefully millions of American families will have modified their home loans. And, if that is the case, then those families will not experience any “loan forgiveness” until many years from now.

In fact, for discussion purposes, if we assume that many of these homeowners will not sell their homes for 8 to 10 years, then we need the act extended to 2022. We cannot create a situation where a homeowner has been encouraged to stay in their home with financing that exceeds the home's worth, only to then extract thousands of dollars in taxes from them if and when the home is sold for less than the outstanding balance.

The practical reality is while loan modifications (or HARP 2.0 refinancings) result in reduced monthly payments, the borrower still owes the lender much more than the home is worth.

In order to continue encouraging homeowners to seek loan modifications, the act cannot be allowed to lapse and thus create a situation where all presently underwater borrowers need to weigh the tax implications of owning their home past the end of 2012.

Comments (1)
Simply put, any forgiveness of debt, prior to the act was taxable income to the IRS. If the act is not extended, the forgiven debt will become taxable income once again. So, for example, if a home with an outstanding loan balance including any capitalized costs, totaling $300,000, but the short sale price the Bank/Mortgage Company approved was $250,000, we have a forgiveness of debt equal to $50,000. Under the old rules that $50,000 was reported to the IRS as Debt Forgiveness and added to the Mortgagor's taxable income for the year the sale took place. The act made this $50,000 non-taxable and forgiven. If the act is not extended, we will have years of maybe millions of homeowners that are in the poorest situation and can least afford to pay this added tax. Additionally, this acts totally opposite what a stimulus strategy is trying to accomplish because it will have a direct impact on disposable income.
Posted by ROBERT R | Wednesday, March 14 2012 at 10:38PM ET
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