Tax Bomb for Consumers May Implode Short Sales

Homeowners could soon be hit with a massive tax bill they can’t afford. Image: Fotolia

Residential servicers are completing nearly 100,000 short sales every three months, giving former owners a few thousand bucks to pack their belongings and start a new life without any mortgage debt.

At this point in time, the amount of mortgage debt forgiven is not taxed as ordinary income under a law Congress passed in 2007 to help struggling homeowners. Over the next two months, borrowers who benefited from a short sale or a principal reduction loan modification will not get hit with a tax bill.

But all that could change soon if Congress allows the mortgage forgiveness debt relief provision in the tax code to expire on Jan. 1.

“Think of all the short sales and debt forgiveness where the bank works to help the homeowner. And then the homeowner gets a bill from the IRS, if this provision is not extended,” said Scott Talbott, a lobbyist for the Financial Services Roundtable.

The tax on mortgage forgiveness only extends the homeowner’s misery while producing little tax revenue. “If the homeowner is having trouble paying their mortgage,” he said, “they will have a harder time paying the Internal Revenue Service.”

The roundtable is leading a lobbying effort to make sure the mortgage debt relief provision is extended. “We are meeting with members of Congress. We are working with other trade groups,” Talbott said. “This is a very important provision for the mortgage industry.”

Before Congress left town in August to campaign for the November elections, the Senate Finance Committee approved a bipartisan bill to extend scores of tax credits and deductions for another year that benefits individuals, businesses as well as the mortgage industry.

The total price tag for the extension bill is $205 billion. It includes a one-year extension of the mortgage forgiveness debt relief provision at a cost of $1.3 billion. Another provision in the tax bill allows homeowners to deduct the cost of mortgage insurance for another two years. The MI provision costs $1.3 billion.

In the House, two members of the Ways and Means Committee have sponsored separate bills to extend the mortgage forgiveness debt relief provision.

A bill sponsored by Rep. Tom Reed, R-N.Y., calls for a one-year extension. “Loan modifications, short sales and foreclosures are frequently the result of job loss. Relieving this large unanticipated tax burden will help those experiencing what is often the single largest financial loss of their lifetime,” Reed said. The Reed bill has 34 co-sponsors.

A bill sponsored by Rep. Tom Dermott, D-Wash., extends the mortgage debt relief for three years. The five megabanks that signed the national foreclosure settlement have three years to fulfill their obligations under the settlement negotiated with the state attorneys general.

“Over the next three years, tens of thousands of homeowners will get mortgage relief under the national foreclosure settlement. But, if Congress doesn’t act, these homeowners will be hit with a massive tax bill they can’t afford. Extending the tax exclusion for an additional three years will not only provide meaningful relief to struggling homeowners, but allow deserving families to keep their homes,” McDermott said.

One provision in his bill provides tax relief for military service members whose homes were foreclosed on while they were deployed overseas. The bill excludes the damages they receive from the banks. It also prohibits the banks from deducting those payments from their taxes.

The McDermott bill has 47 co-sponsors, including all the Democratic members of the House tax committee. Observers claim it will be very difficult to a get a three-year extension through the House because of the cost.

The Senate tax committee approved its tax extension bill by a 19-5 vote, but not before the senators jettisoned 20 tax provisions to reduce the costs, including a cash incentive program for wind-energy projects. Normally, the House and Senate tax writing committees don’t have to make such cuts. But these are not normal times.

When the lawmakers return to Washington after the elections, they will have to deal with several yearend deadlines—the expiration of the Bush tax cuts and automatic spending cuts of $1.2 trillion. How Congress resolves or postpones this pending “fiscal cliff” is still up in the air.

Meanwhile, deficit hawks will be looking to trim the $205 billion price tag. The mortgage insurance provision appears vulnerable. But the Financial Services Roundtable senior vice president wants to see it in the final bill.

“It is important to use the tax code to support the housing industry and secure a sustainable recovery,” Talbott said.