Part of a distressed sale—a foreclosure or a short sale—or a loan modification entails the mortgage lender forgiving some or all of a homeowner’s debt. Formerly, tax laws counted that forgiven amount as taxable income. But in 2007, President George W. Bush signed legislation that temporarily exempted forgiven mortgage debt from taxable income. That law expires December 31—unless Congress acts to extend it.
Without an extension, “you’re going to be taxed on a gain when you didn’t really gain anything,” says Brian Bernardoni, the senior director of government and public policy at the Chicago Association of Realtors. “Folks who have already gotten wiped out will have to pay for that privilege.”
The push is on to get an extension. In the U.S. House of Representatives, Resolution 4336 and Resolution 4202 aim to extend the tax forgiveness. Seven of Illinois’s 18 members of the House are cosponsors of one bill or the other. Neither of Illinois’s senators is among the 19 cosponsors of Senate bill 2250, which also provides for extending mortgage debt tax relief.
Taxing forgiven mortgage debt “would impose a significant financial burden on struggling homeowners and present those who have suffered through the short sale process an additional heavy burden,” Representative Jan Schakowsky (D-9th) said in a prepared statement. “The result would be disastrous to our overall economy and Chicagoans who are struggling [over whether] to keep or walk away from underwater homes.”
Last week, the attorneys general of 41 states, including Lisa Madigan of Illinois, signed a letter to Congress urging passage of the extension. In a statement issued at the time, Madigan said, “Failure to extend this tax relief would hurt the very families we set out to help in the national foreclosure settlement. We need to do everything we can to encourage—not deter—struggling homeowners to seek help to stay in their homes.”
The 2007 legislation passed at a time when it wasn’t yet clear that the housing crisis would persist for more than five years. But with the market still struggling to revive—the Case-Shiller index data released Tuesday shows that, in the Chicago area, home prices in September 2012 had only returned to their September 2001 level—short sales and foreclosures aren’t going away. According to Midwest Real Estate Data, there were 30,229 short sales and foreclosures in northern Illinois in the first ten months of 2012. There were 30,077 in all of 2011.
There is no clear data on how much debt individual home-sellers have been forgiven. The Congressional Budget Office estimates that allowing the exclusion to expire would cost forgiven homeowners about $1.3 billion in taxes.
And that, says Bernardoni, is what makes the difference between the extension being an obvious no-brainer and a sticky question. It’s easy to understand that people who lose their homes to foreclosure or sell for less than the amount of the mortgage aren’t profiting and thus shouldn’t be taxed as if they collected a windfall. But the political winds these days are blowing against tax relief of any kind. “This could be one of the unintended consequences of a deal to avoid the fiscal cliff,” Bernardoni says. “Singling out any one group for tax relief is going to be difficult.”
None of the measures call for making mortgage-debt tax relief permanent; they only call for an extension while the real-estate market continues to stagger. Nursing along housing’s recovery is an essential part of stabilizing the larger U.S. economy, as Mesirow Financial’s Diane Swonk wrote just before Thanksgiving. “Housing is finally showing signs of healing after a prolonged illness,” she explained. “We still have a long way to go, but it has reached a critical shift in momentum, if allowed to continue; the choice is in the hands of our elected officials, and the clock is ticking.”
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