Mortgage Forgiveness Debt Relief Act on a fiscal cliff

by Broderick Perkins

(12/22/2012) With the Mortgage Debt Relief Act set to expire just as revelers ring in the New Year, advocates for mortgage relief were desperately appealing to Congress for an extension.

Without an extension of the law that excludes forgiven mortgage debt from taxation, an untold number of households could fall off their own fiscal cliff.

In a joint appeal from the Housing Policy Council (HPC) and the Center for Responsible Lending (CRL) heads of those groups wrote "...the housing market is beginning to show signs of recovery and an expiration of this law would threaten that recovery."

The law, officially called the "Mortgage Forgiveness Debt Relief Act," is federal tax law that allows qualified taxpayers to exclude from taxation, income derived from the forgiveness or discharge of debt associated with a principle residence.

That could be debt forgiven for a short sale, foreclosure or other mortgage workout.

The provision is set to expire Dec. 31, 2012.

MDRA originally came with a mortgage insurance tax deduction, which actually benefitted more mortgage consumers than forgiven deb provision. Unfortunately, the tax deduction expired in 2011.

The National Association of Attorneys General (NAAG) also admonished federal lawmakers, "Unless Congress acts, all of the remaining debt relief to be provided under the National Mortgage Settlement, as well as other mortgage debt relief programs, will likely be considered taxable income. Language already exists in Section 112 of the Family and Business Tax Cut Certainty Act (S. 3521) to extend the tax relief."

NAAG nagged, "We strongly urge Congress to extend this critical tax exclusion, which expires on December 31, 2012, so that distressed homeowners are not stuck with an unexpected tax bill or deterred from participating in this historic settlement."

The exclusion applies to up to $2 million ($1 million if married and filing separately) in forgiven debt for calendars years 2007 through 2012, but only if the forgiven debt qualifies. The forgiven debt must be related to a decline in the home's value or due to the taxpayer's financial situation.

Only forgiven debt on principal residences qualify. There's no tax exclusion for debt forgiven on vacation homes, investment properties and other second homes.

The tax exclusion can apply to refinanced debt, but only if the principal balance of the old mortgage, immediately before the refinancing, would have qualified, or you have documented receipts showing cash-out refinance funds were used for home improvements.

Without an extension, homeowners trying to avoid foreclosure would effectively be penalized for a short sale, mortgage modification or other mortgage workout that comes with debt forgiveness.

Given the time it takes to approve a short sale or mortgage modification many households are already out of luck, unless the rule is extended.

"If Congress allows the law to expire, then homeowners who are working with their servicer could end up owing more in taxes...This would make it more difficult and expensive for these homeowners, who are already financially struggling, to accept short sales and many loan modification offers," according to the HPC-CRL letter.