WASHINGTON » Struggling homeowners who obtain reductions in their mortgage debt face a new obstacle starting next year: a bill for taxes on that aid.
A special exemption of as much as $2 million per household in principal reduction and other aid from banks, in place since 2007, is set to expire at year’s end.
It is one of a number of similarly expiring tax provisions — most notably the President George W. Bush-era tax cuts — and the automatic government-spending reductions looming at the same time that are referred to as the fiscal cliff.
Housing advocates and lawmakers are worried that the exemption will disappear just as thousands of homeowners are receiving large amounts of mortgage debt relief from the nation’s five largest banks as part of a national settlement of foreclosure abuse investigations.
"The expiration of that provision is a hidden time bomb," said Rep. Jim McDermott, D-Wash.
He and other lawmakers are expected to push for an extension of the special tax exemption when Congress returns from summer recess next week, but even with bipartisan support, it’s unlikely to get a vote before the November election.
And all bets are off on any legislation getting enacted in a turbulent post-election session later this year in which lawmakers must grapple with the divisive fiscal cliff issues.
As the clock ticks on the mortgage debt exemption, concern is rising.
"We are actively looking for opportunities to extend the provision, and we would hope we could do that well before the end of the calendar year," Housing and Urban Development Secretary Shaun Donovan said.
Mortgage debt that is forgiven by a bank as part of a principal reduction, short sale or foreclosure must be reported as income by the homeowner and is subject to taxes. The lender reports the amount forgiven on a special Internal Revenue Service form.
But in 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act to give struggling homeowners a break. If the debt is forgiven because of a drop in a home’s value or a decline in the owner’s financial condition, up to $2 million of the relief for couples filing jointly is exempted from federal taxes.
The exemption on what has been called shadow income — relief that can amount to tens or hundreds of thousands of dollars — originally was supposed to expire at the end of 2010. But with the housing market and economy in free fall in 2008, Congress extended the break until the end of the 2012 tax year.