For those who experienced, even tangentially, some of the fallout from the housing and foreclosure crisis, circa 2007/8 – 2012, most are aware of the tax exclusion given borrowers who received some form of debt forgiveness from a lender.
By way of refresher, this all relates to The Mortgage Debt Relief Act of 2007 (“the Act”). IRC 108 provides that generally, debt relief given from a lender to a borrower is a taxable event.[1] The Act, however, allowed taxpayers to exclude from their gross income, debt that a lender or servicer cancelled when it arose from a short sale, deed-in-lieu, foreclosure, or certain mortgage modifications. However there are some limitations:
- The property must have been the debtor’s primary residence;
- It must have been occupied two of the past five years;
- The borrowed funds must have been used to buy, build, or substantially improve the home[2]; and
- The maximum amount of principal eligible for exclusion is $2 million if married, filing jointly, and $1 million, if married filing separately.
The Act has been repeatedly extended over the years. According to the summary provided by the House Ways and Means Committee (here), HR 2029, The Consolidated Appropriations Act, Division Q, Sec. 151, extended the taxpayer protection through 2016, and even applied the tax exclusion to discharges claimed in 2017, but only if they were pursuant to a written agreement entered into in 2016.
Despite everyone’s hopes that the foreclosure crisis would now be a thing of the past, that has not been the case. Conditions are admittedly much better, but many folks continue to be at risk of some form of distressed housing event, which may ultimately trigger the recognition of taxable income on the resulting debt relief.
Recently, S. 122, the “Mortgage Debt Tax Relief Act” was introduced by Finance Committee Members Heller, Stabenow, Menendez, and Isakson. It would extend tax relief to 2019. This would give protection to those folks who experience debt relief in 2017 that was not pursuant to a written agreement entered into in 2016, and continue it on through calendar year 2018. Right now they have no protection, and without a fix, will have to declare the amount forgiven as taxable income.
On May 9, 2017, in a letter to the entire U.S. Senate, National Association of REALTORS® President William E. Brown stated:
While in many areas, the housing market has certainly experienced gains along with the broader economy, recent estimates by the real estate data analytics firm CoreLogic, show that about 3.2 million (over 6 percent) homeowners with mortgages in the U.S. are still “under water.” Further, the Mortgage Bankers Association estimates there are still nearly 600,000 homes in the process of foreclosure across the nation. In short, it is clear that this legislation is needed now as much as ever.
Will all this fall on deaf ears? Will the law ultimately be extended? Will Dudley Do-Right arrive in the nick of time to untie the beautiful Nell from the tracks before catastrophe strikes?
The good news is “yes, very likely, if the past several years are any predictor”. We have seen this movie several times, and it always ends well, but not before much handwringing. The bad news is that this bill, which involves the extension of tax relief (and has bipartisan support), is merely a small piece of a much larger process – nay, Kabuki Dance – involving “tax extenders”, which is the political equivalent of horse-trading, that takes time – maybe even through the end of 2017.[3] For a summary of this Machiavellian process, go to my blog post here.
So the take-away is that we should plan on the law passing, but when it will occur is unknown. Certainly, readers can track the process of the bill by going to the link here. In the meantime, for diversion and comedy relief, we can focus on the newest reality show that is the Washington Press Corp. vs. the White House. ~PCQ
[1] Oregon follows the federal rules in allowing debt relief for mortgage forgiveness.
[2] This also includes any debt secured by a primary residence used to refinance the home mortgage, but only up to the amount of the old mortgage’s principal just before the refinancing. Taking cash out for any reason, e.g. debt consolidation, student loans, divorce settlement, etc. is not protected, i.e. if cancelled, it’s subject to ordinary income tax. [I suspect if the refinance funds were used to substantially improve the home, it might also be exempt if later cancelled, even though the refi funds exceeded the then-existing principal balance of the original mortgage. However, this should be verified with a tax lawyer or CPA. I am neither.]
[3] In one instance, the extender legislation was not passed until January of the following year, and retroactively applied to include the prior one.
