Here’s some encouraging news for financially stressed homeowners across the country: The Senate Finance Committee approved a bipartisan bill before heading home for summer recess that would extend the Mortgage Forgiveness Debt Relief Act through 2013.
Why is this important? Several reasons: The debt relief law spares homeowners who receive principal reductions on their mortgages from being hit with hefty federal income taxes on the amounts forgiven. Without it, millions of owners who go through foreclosure or leave their homes following short sales would experience even more financial stress.
The law, which has also provided relief to thousands of people who have debt balances written off as part of loan-modification agreements and is crucial to the $25 billion federal-state robo-signing settlement with large banks, is set to expire at the end of December. Some Capitol Hill analysts predicted that, along with a host of other special-interest tax benefits, an extension might have trouble making it through the partisan gantlet in an election year.
But the Senate committee managed to pull together enough votes Aug. 2 to pass the debt-relief extension, after heavy lobbying by the National Association of Realtors and the National Association of Home Builders. The bill, which now moves to the full Senate for possible action next month, also would extend tax write-offs for mortgage insurance premiums for 2012 and through 2013, and continue some energy-efficiency tax credits for remodelings and new home construction.
The mortgage debt relief extension could ultimately affect millions of families who are underwater on their loans, delinquent on their payments and heading for foreclosure, short sales or deeds-in-lieu of foreclosure settlements. Under the federal tax code, all types of forgiven debt are treated as ordinary income, subject to regular tax rates. When an underwater homeowner who owes $300,000 has $100,000 of that forgiven as part of a modification or other arrangement with the bank, the unpaid $100,000 balance would normally be taxable.
But in 2007, Congress saw the fast-mounting distress in the housing market on the horizon and agreed to temporarily exempt certain mortgage balances that are forgiven by lenders. The limit is $2 million in debt cancellation for married individuals filing jointly, $1 million for single filers. This special exemption, however, came with a time restriction. The current deadline is Dec. 31. Without a formal extension by Congress, starting on Jan. 1 all mortgage balances written off by banks would be fully taxable — a nightmare scenario that has had financially stressed homeowners worried for months.
These apprehensions were raised even higher when some policy analysts predicted that a Congress as fractious and dysfunctional as the current one would never get its act together to pass any tax bills until the closing moments of the lame-duck session expected after the November election. Even then, with issues like the mounting federal debt and draconian spending cuts scheduled for Jan. 1 taking precedence, smaller tax extensions such as mortgage debt relief might well be lost in the dust storms, experts predicted.
A few Republican policy strategists, including Douglas Holtz-Eakin, former Congressional Budget Office director and economics adviser to Sen. John McCain’s presidential campaign, speculated that tea party freshmen in the House might oppose the debt-relief extension because they see it as another costly bailout funded by taxpayers. The estimated revenue cost to the Treasury for a two-year extension is $2.7 billion.
The mortgage insurance deduction is another key housing benefit that made it into the Senate committee’s 11th-hour extender bill. Mortgage insurance generally is required whenever home purchasers make small down payments, whether on conventional, private market loans or government programs. Under a provision in the tax code that expired last December, certain borrowers could write off their mortgage insurance premiums on their federal income taxes, just as they do with mortgage interest. To qualify for a full deduction, borrowers could not have adjusted gross incomes greater than $100,000 ($50,000 for married taxpayers filing separate returns).
The Senate’s bill would extend the write-off retroactively to this past Jan. 1, and would continue it through December 2013. No buyer or owner who planned to write off premiums during 2012 would be penalized, in other words, despite the expiration last December.
The outlook for the extenders: Given the popularity of the housing deductions and credits, look for supporters to press the full Senate for early action in September in order to get these issues settled before Election Day. If there are serious objections in the Republican-controlled House, however, then all bets are off until the lame-duck session, when election losers as well as winners get to write federal tax policy.