Although economists predicted that 2013 would bring prosperity to the housing market, ending the Mortgage Debt Relief Act would have dampened those optimistic forecasts.
Amid the short sale/foreclosure housing crisis in 2007, the Mortgage Debt Relief Act provided a tax break on taxable income for loan balances of up to $2 million ($1 million for someone who is married but filing a separate return).
For years the Act helped to save Americans thousands of dollars, becoming one of the many tools used to prop up a failing economy. Forbes Magazine financial writer, Morgan Brennan provided a real life example of how the Mortgage Debt Relief Act has been beneficial for so many troubled homeowners.
“So if, say, a homeowner facing foreclosure offloads his underwater home with a $295,000 mortgage attached in a short sale for $200,000, he would not have to pay federal taxes on that $95,000 forgiven principal amount that neither he nor the lender will ever see again,” she wrote last month.
The Mortgage Debt Relief Act was in jeopardy of falling off the fiscal cliff as it was set to expire at midnight on December 31, 2012. Fortunately, lawmakers understood the importance of extending the Act for another year.
“That homeowner who has been forgiven $95,000 in mortgage principal could owe as much as $33,000 in taxes,” Brennan adds. “That’s tens of thousands in taxes on so-called ‘earned income’ that no longer exists anywhere but in the loss column of a bank’s balance sheet.”
San Diego, California housing analyst Alan Nevin says that extending the Mortgage Debt Relief Act saves the homeowner from taking a total loss on a property. "If it was not extended, there would've been a number of people who also would have just let their homes go back to the lender," he told The San Diego Union-Tribune.
Lawmakers Urged by the Credit Union Industry
The Credit Union National Association (CUNA) was among the many national and local groups pushing for the Mortgage Debt Relief Act extension.
In December CUNA, along with the National Association of Realtors and other financial industry groups penned a letter to Senate Majority Leader Harry Reid (D-Nev.), Senate Minority Leader Mitch McConnell (R-Ky.), Speaker of the House John Boehner (R-Ohio) and House Minority Leader Nancy Pelosi (D-Calif.), urging them to "ensure renewal of the Act before the end of this year in order to help as many underwater homeowners as possible."
The credit union industry has been diligently keeping members up to date on why the Act is important and that homeowners can avoid foreclosure due to this piece of legislation.
In addition to being able to exclude up to $2 million of debt forgiven on your principal residence (and the limit is $1 million for a married person filing a separate return, important reminders on the list include:
You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.
To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
Proceeds of refinanced debt used for other purposes (for example, to pay off credit card debt) do not qualify for the exclusion.
If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.
Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, other tax relief provisions, such as insolvency, may be applicable. IRS Form 982 provides more details about these provisions.
If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.
Examine Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.