Struggling homeowners could be hit with an unexpected tax bill in the new year. A law that spared people who owe more than their homes are worth from being saddled with extra taxes when their banks provide mortgage relief expired on January 1. Congress has not yet extended it.
Underwater homeowners often try to negotiate with their bank so that they can sell their homes for less than they owe in a short sale or have their mortgage balance reduced. But the difference between what the homeowner owes and the lower sales price approved by the bank is considered income for the homeowner and subject to tax by the Internal Revenue Service.
For example, someone with a $100,000 mortgage who is allowed to sell their house for $80,000 is supposed to pay taxes on the remaining $20,000.
But a law known as the Mortgage Forgiveness Debt Relief Act saved such homeowners from the tax burden. Last year, Congress rushed to extend the law during negotiations about the fiscal cliff but only through the end of 2013.
Lawmakers and housing advocates argue that the rule hurts those who are already financially strapped. Since 2009, more than 220,000 homeowners have sold their houses for less than they were worth through a short sale. There are more than 6 million homes still underwater across the country, according to a third-quarter report from research company CoreLogic.
That is down from more than 11 million homes during the peak of the housing crisis in 2009, but it shows that despite the sector’s strong recovery, many homeowners aren’t out of the woods.
“What you’re looking at is people who have lost their house,” said Marceline White, executive director of the Maryland Consumer Rights Coalition. “And then to have them hit with this [tax] just boggles the mind.”
At the federal level, there are three bills — two in the House and one in the Senate — that call for the law’s extension. One of the House bills enjoys strong bipartisan support, with 29 Democrats and 23 Republicans on board. The Senate bill — which would extend relief through 2015 — is sponsored by Sens. Debbie Stabenow (D-Mich.) and Dean Heller (R-Nev.). Stabenow sponsored the extension last year.
It is yet unclear whether Congress will make the law a priority this year. We’re far from out of the foreclosure crisis. If you are considering a short sale, this is one decision that you should pay close attention to in the new year.