Homeowner tax cut extended; forgiven mortgage debt excluded from taxable income

Article Courtesy of The Palm Beach Post

By Kimberly Miller

Published January 4, 2013

Florida homeowners have one more year to complete a short sale and benefit from a federal tax break that was set to expire Tuesday.

Tucked into the 157-page legislation that saved the nation from the worst of the fiscal cliff is an extension of the Mortgage Debt Relief Act, which allows borrowers to exclude loan debt forgiven in a short sale, foreclosure or loan modification from counting as income on their taxes.

The act has saved struggling Floridians untold millions since it began in 2007. Tuesday’s approval of the American Taxpayer Relief Act of 2012 extends its deadline to Jan. 1, 2014.

“It’s an enormous relief,” said Sherry Lee, broker/owner of Lee Property Sales in West Palm Beach. “My Christmas and New Year’s was spent consoling sellers and trying to talk them through that process of realizing the act might not be extended and what that means.”

One of Lee’s clients has a short sale contract that will result in $165,000 in forgiven debt. Without the act, she would have to pay about $46,200 in taxes on the so-called “phantom income” under 2012 tax rates. Depending on the amount forgiven, homeowners coould also be pushed into a higher tax bracket, meaning they’d not only owe on the debt but also at a higher rate.

“She was so stressed out, her stomach was in knots over this,” Lee said about her client.

The extension is particularly crucial in South Florida, where homeowners have seen housing prices plummet 46 percent since the area’s peak market in December 2006, according to the October Standard & Poor’s/Case-Shiller index.

Realtor Jared Dalto said while many sellers are breathing a sigh of relief, they need to remain diligent and not count on another tax break extension.

“If I were a seller, I would make sure this is the year of the short sale,” he said.

To avoid a lengthy foreclosure process, lenders have increasingly approved short sales — where the bank agrees to a lower sales price than what the borrower owes on the mortgage.

But not everyone can benefit from the debt relief legislation. It covers only forgiven debt on principal residences and amounts up to $2 million, or $1 million if married but filing separately. The act also does not apply to second mortgages where the money was used for non-household expenses.

The pending expiration had Realtors racing to complete sales by Dec. 31, and roused the lobbying efforts of the nation’s attorneys general who worried its sunset would dilute the $25 billion national mortgage settlement. Without the extension, principal reductions and other debt relief offered in the settlement would be considered taxable income.

The settlement has already provided for $386.7 million in primary mortgage principal forgiveness for Florida homeowners. Another $2.2 billion statewide has been forgiven through short sales.

“This extension will help struggling homeowners take full advantage of the assistance offered them by the national mortgage settlement and other foreclosure relief programs,” Florida Attorney General Pam Bondi said Wednesday. “We need to continue to do everything we can to help Floridians who are doing the best they can to pay their bills and stay in their homes.”

The Congressional Budget Office estimated extending the relief could cost $1.3 billion in lost revenue to the federal government.

Anthony Sanders, a George Mason University real estate finance professor, predicted last month the extension would be approved. He just didn’t know when or in what form.

On Wednesday, he called the overall legislation to avert the fiscal cliff “dreadful”, saying it adds $4 trillion in federal budget deficits over 10 years.

But he supported the debt relief extension.

“The government was a major contributor to the housing bubble and burst, so it’s only fair that it extend the act to help households that have been absolutely crushed by the market,” he said last month.