The Mortgage Forgiveness Debt Relief Act of 2007, signed into law by President Bush, enables struggling homeowners to avoid paying taxes on forgiven mortgage debt from short sales or loan modifications. The tax break was scheduled to expire in the new year, but has been extended through 2013.
Without the break, forgiven debt can be treated as taxable income, and already struggling homeowners would face taxes from a short sale or loan modification. For example, an underwater homeowner in the 25% tax bracket could pay $12,500 in taxes for a short sale in which his house sold for $150,000, but he previously owed $200,000. With the tax break, the homeowner would not have to pay taxes on the $50,000 of forgiven debt.
Extending the tax break has support from both the financial-services community and consumer advocates.
“This tax law has bipartisan support and is critical to helping homeowners and communities struggling with the ongoing foreclosure crisis. Furthermore, the housing market is beginning to show signs of a recovery, and expiration of this law would threaten that recovery,” according to a November letter from chiefs with the Financial Services Roundtable, Center for Responsible Lending and Housing Policy Council to U.S. lawmakers.
Before a fiscal-cliff deal was reached, analysts warned that allowing the debt-forgiveness break to expire could hit a recovering housing market.
“This relief has helped to boost short sales—a smoother way to sell a distressed property, helping the recovery in home prices. If this is not extended, a greater share of delinquent borrowers will likely be resolved through foreclosure instead of short sale, which would depress average home prices,” according to a research note from analysts with Bank of America Merrill Lynch.
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