The Senate Finance Committee approved a bipartisan bill before summer recess that would extend the Mortgage Forgiveness Debt Relief Act through 2013.
The debt relief law spares homeowners who receive principal reductions on their mortgages from being hit with 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 by being taxed on the amount of debt that the lender forgave in the short sale or that was not recovered in the foreclosure sale. The law has provided relief to thousands of people who have debt balances written off as part of loan-modification agreements is set to expire at the end of December 2012.
The bill 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 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.
In 2007 the Mortgage Debt Relief Act 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, 2012. Without a formal extension by Congress, starting on Jan. 1 all mortgage balances written off by banks would be fully taxable.
There are five bills in Congress, so hopefully one of them will make it through for the homeowner.