Early next year, thousands of American homeowners may get an unpleasant surprise in the mail: a tax statement from their mortgage lender announcing that they may owe tens of thousands of dollars in federal income taxes.
Unless Congress acts before the end of 2015, homeowners who had their mortgage principal reduced in a loan modification or lost their homes through a foreclosure or short sale will find themselves in this position.
Under the federal tax code, when a lender forgives part or all of a mortgage, the borrower must count that forgiveness as taxable income. Congress recognized that this tax rule would discourage debt forgiveness as a tool to reduce foreclosures and approved the Mortgage Debt Forgiveness Relief Act in 2007. It has since been extended twice and expired again at the end of 2014. Unless the act is renewed again, mortgage debt that has been forgiven will once again be deemed as taxable income. Homeowners will have to pay tax on that income, whether or not they saw a dime of it.
This is unfair to the many Americans who lost their homes, jobs and nest eggs as a result of the housing crisis. As the federal government is encouraging servicers to modify the mortgages of struggling homeowners through principal reduction programs such as the Home Affordable Modification Program, it yet stands ready to tax this phantom income. Meanwhile, big commercial banks are permitted to write off the billions of dollars of debt relief that they were required to provide homeowners as part of the national mortgage settlement between government regulators, lenders and servicers.
It's particularly ironic that this is happening even as Ocwen Financial has been aggressively modifying the mortgages of struggling homeowners — essentially complying with the mandate of their own 2013 settlement with the Consumer Financial Protection Bureau, state attorneys general and other regulatory agencies. Under this settlement, Ocwen committed to principal reduction modifications of $2 billion over a three-year period. While Ocwen and other servicers should be commended for their efforts, that work may be for naught if homeowners have to pay for this debt relief in the form of large, unexpected tax bill.
It can be argued that Congress still has plenty of time between now and the end of this year to pass another extension. Indeed, it has done so before, often in late December. But until then, homeowners in this predicament will have a potentially large tax obligation hanging over their heads. That's why it is critical that Congress act now and not wait until the end of the year. We don't need to burden already-anxious homeowners with even more stress.
This issue affects real people. Last year, a homeowner our agency worked with was forced to sell his house in a short sale for $150,000, even though he still owed $250,000 on his mortgage. If Congress hadn't come through with an extension at year-end, he would have owed over $28,000 in income taxes on that $100,000 difference. He had no hope of paying such a sum.
Two bills have been introduced in Congress that would further extend the Mortgage Debt Forgiveness Relief Act for two more years: S. 608 in the Senate and H.R. 1002 in the House. While extending the act into perpetuity may not be politically possible, an extension of several years is certainly not unreasonable, given the number of homeowners still struggling to pay their mortgages or contemplating a short sale or other settlement for less than what they owe.
It would be a shame if the hard work of many mortgage lenders and servicers, community groups and others was wasted by congressional inaction. It is important that our representatives support both bills, demonstrating that the American public should not suffer a double jeopardy in their financial lives even as the ripple effects of the foreclosure crisis continue.
Lou Tisler is executive director of the Neighborhood Housing Services of Greater Cleveland.