This excerpt is from David Dayen’s article, “The Government Guide to Screwing Poor Homeowners.” Full article here:
The end of the Mortgage Forgiveness Debt Relief Act, which lapsed December 31, means that any type of debt forgiveness on a mortgage will result in a giant tax bill—one that a stressed homeowner cannot usually afford. Even homeowners entitled to compensation for past abuse by the mortgage-lending industry would be subject to unfavorable tax treatment. This will lead to more economically debilitating foreclosures and weaken the housing market. Despite bipartisan support for an extension, it’s anybody’s guess whether Congress will get around to helping out struggling homeowners.
The Mortgage Forgiveness Debt Relief Act dates back to 2007. When the housing bubble collapsed, millions of homeowners fell into a Great Recession-induced crisis of lost wages and plummeting property values. Principal reductions—cuts to the unpaid balance of a home loan—have been proven time and again to be the most effective method for a homeowner to avoid foreclosure. But there was a problem: For tax purposes, the IRS treats forms of debt relief like principal reduction as gross income. So a $100,000 principal reduction for a family making $50,000 a year would force them to pay taxes as if they earned $150,000, saddling them with a federal tax bill (according to this calculator) of $32,493, or over two-thirds of their annual income. Struggling homeowners don’t typically have bags of cash lying around to pay off tax bills.
In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act, exempting mortgage debt forgiveness from taxation. The law was extended twice as the foreclosure crisis lingered. It made it into the 2012 “fiscal cliff” deal at the last minute, extending relief through the end of 2013. But it expired last week, putting homeowners on the hook.
The need for mortgage relief is pressing. The most recent statistics show nearly 4.5 million homes are in some stage of delinquency. And more than 6 million homesare “underwater,” with the homeowner owing more than the home is worth. These homes are at risk of foreclosure, but many lower-income borrowers who can’t afford the tax bill will have to turn down mortgage help. Housing advocates were hopeful that the confirmation of Mel Watt to run the Federal Housing Finance Agency, the conservator for Fannie Mae and Freddie Mac, would lead to those agencies (which own or guarantee 90 percent of all new mortgages) finally offering principal reductions to prevent foreclosures. But the tax situation makes Watt’s confirmation irrelevant on this point.