The clock is ticking on a tax break that saves struggling homeowners from paying thousands of dollars to the IRS.
If the Mortgage Forgiveness Debt Relief Act of 2007 does not get
extended by Congress by the end of the year, homeowners will have to
start paying income taxes on the portion of their
mortgage that is forgiven in a foreclosure, short sale or principal reduction.
So if you owe $150,000 on your home and it sells for $100,000 in a
foreclosure auction, the IRS could tax you on the remaining $50,000. For
someone in the 25 percent tax bracket, that would mean paying $12,500
in taxes on the foreclosure. Similar taxes would apply for forgiven
amounts in short sales and principal reductions.
Related: How a Short Sale or Foreclosure Affects Your Credit
"People trying to do short sales are freaked out about it," said
Elizabeth Weintraub, a real estate agent in Sacramento, Calif. "They're
telling me they'll do whatever it takes to close by the end of the
Should the tax break expire, a large number of mortgage borrowers could
be affected. More than 50,000 homeowners go through foreclosure each
month. Meanwhile, the number of short sales has tripled over the past
three years to a rate of about half a million a year. And, under the
terms of the
$25 billion foreclosure abuse settlement, roughly 1 million borrowers may have their mortgage debt lowered through principal reductions over the next couple of years.
"If there ever was a no-brainer in housing policy, this would be it,"
said Jaret Seiberg, a policy analyst for Guggenheim Securities.
Yet, Seiberg is skeptical the exemption will get extended. Now that the
election is over, he thinks Congress will be heading into a "lame duck"
session, and very little legislation will move forward through the end
of the year.
Related: Are Short Sales Worth the Trouble?
In addition, the cost of the exemption could make it a point of
contention, he said. The office
of Sen. Max Baucus, who heads the
finance committee, estimated the cost of a one-year extension at $1.3
Yet, others disagree. Tom Kolpien, the press secretary for Rep. Tom Reed
of New York, said Congress will likely act before the end of the year.
(Reed is currently pushing for the extension on the House Ways and Means
"Both parties, both houses of Congress agree it's good policy and it
needs to get done," said Jamie Gregory, chief lobbyist for the National
Association of Realtors, which supports an extension. "The holdup is the
process. I'm confident it will get done. I just don't know how."
Even if Congress allowed the exemption to expire, not all borrowers with
forgiven mortgage debt will take a tax hit. If the debt is discharged
in a bankruptcy, no tax is due. And anyone who is insolvent -- meaning
they have more debt than assets at the time the debt was forgiven --
would not have to pay the tax.
Also, in some states like California, certain borrowers are protected
against paying the tax because of the way the state treats foreclosures.