Residence Mortgage Forgiveness Tax Relief
Note: HR 3648 finally passed and was signed, but with some changes.
For an update see
Residence Mortgage Forgiveness Tax Relief - Finally!.
As we roll through 2007 one of the biggest tax issues relates to mortgage cancellation.
The problem is that many homes are "upside down" in that the current mortgage exceeds the fair market value of the house.
Complicate this with those mortgages being fixed at an atrificially low interest rate with a change after a few years.
Many of those adjustments are now starting to happen, and as they do, the monthly payment increases significantly.
This becomes a tax issue because, in many cases, the loan amount that is "forgiven" is taxable income.
So not only does a family suffer from the loss of their home, but then they are hit with a large tax bill.
Congress is certainly looking at providing some relief by a change in the the tax law.
However, at the end of September that has not yet been done.
But we do have a few clues to what is happening.
And while there is not yet a bill passed, the legislative gears are turning ever so slowly.
It will be a couple of months yet before we know what relief we will finally see, but we can look into our crystal ball to get some impression of what is coming.
The past week the House Ways & Means committee passed House bill 3648, meaning it will be sent to the House floor for a vote.
Realize that it has not yet passed the House, nor gone to the Senate, nor to the President for a signature.
Once the bill is considered on the House floor it may be amended, and may not read anything like it currently does.
But looking at this bill does provide some indication of the thinking in the House.
Both Senate bill 1394 and House bill 3648 restrict the relief to acquisition debt on a primary residence (per IRC 121).
This means there will be no relief for investors who have purchased houses to rent for investment purposes.
Furthermore, the provisions are limited to "personal residence" as defined in IRC 121, which applies the "2 of 5" rule.
That is, the seller must have both owned the house and lived in it as their primary residence for an aggregate of 2 out of the preceeding 5 years.
The acquisition debt limitation will impact people who have refinanced their home.
Any additional money taken out of the equity of the house (unless used for substantial improvements) represents mortgage amounts not eligible for relief.
Furthermore, the relief granted under this provision is used to reduce the basis in the home.
In some cases this will create capital gains that exceed the exclusion of IRC 121 and are therefore taxable.
(IRS 121 is the law that allows a seller to exclude $250,000 or $500,000 if married filing joint of the capital gains on the house, providing that the seller has both owned and lived in the house for 2 of the preceding 5 years.)
Senate bill 1394 is stalled in the Senate Finance Committee.
House bill 3506 seems to be dying in committee.
It limited the relief to $50,000, and limited eligible taxpayers to those with Adjusted Gross Income (AGI) of $100,000 or $200,000 if married filing jointly.
This bill not only limited the relief to the acquisition debt but also specified that it must be a first mortgage.
This would restrict relief from a second mortgage that was used to purchase the house originally.
Again, this is not yet law.
But it does show that Congress is interested in assisting those who purchased a home and are now in financial trouble.
The help offered through this action is related to tax relief, so that a family is not also hit with a large tax debt in addition to losing their home.
But Congress is not willing, it seems, to provide assistance to investors who have over extended themselves.
Neither is Congress interested in providing relief to those who have used the equity in their home to pay for non-housing benefits.
(Often these are for a car purchase, or a vacation.)
Obviously this is not a closed issue.
We will continue to watch what Congress does and update where this is headed.