It’s been three months since the Mortgage Debt Relief Act lapsed. It’s a provision in the annual package of tax extenders that keeps homeowners from having to pay income tax on debt that gets forgiven in a mortgage modification or short sale. It’s also a powerful tool to prevent foreclosures and protect struggling homeowners that Congress really ought to renew.
How does the Mortgage Debt Relief Act work? Normally, if you have debt forgiven, the IRS charges you tax on it just like with money you earn (it’s called cancellation of debt income). However, after the housing crash left so many underwater homeowners, Congress rightly realized that the tax burden could make it hard to resolve troubled mortgages. If your monthly payment is too high, adding a tax bill on top of a loan modification might just be too much to manage. If your lender forecloses and you live one of the 38 recourse states, you’d face a tax bill on the unpaid debt in addition to losing your home. So Congress passed the Mortgage Debt Relief Act to exclude discharge of debt on a principal residence (which in IRS-speak means, “your home”).
Until Congress renews the act, people nationwide don’t know whether they can manage a mortgage modification without paying additional tax. Short sales are harder, too, if you don’t know the final cost. And approximately 2 million families have seriously delinquent loans in states where foreclosure would trigger additional tax, according to the Urban Institute. That’s why NHC and many others are calling on Congress to renew the Mortgage Debt Relief Act, and to do so quickly.