On occasion, a lender will forgive some portion of a borrower's debt. The general tax rule that applies to any debt forgiveness is that the amount forgiven is treated as taxable income to the borrower. Some exceptions to this rule are available, but, until 2007, when a lender forgave all or part of a mortgage debt (such as in so-called "short sales," foreclosures and "workouts"), the borrower was required to pay tax on the debt forgiven.
A law enacted in 2007 provided temporary relief to troubled borrowers when some portion of mortgage debt is forgiven. That relief has expired and been extended several times. The last extension provided relief for debt forgiven through Dec. 31, 2016.NAR supports an exclusion from taxation of the "phantom income" generated when all or a portion of a mortgage loan is forgiven.
Current Legislation/Regulation (bill number or regulation)
None at this time.
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What is the fundamental issue?
A lender will, on occasion, forgive some portion of a borrower's debt, or reduce the principal balance. The general tax rule that applies to any debt forgiveness is that the amount forgiven is treated as taxable income to the borrower. Some exceptions to this rule are available, but, until 2007, when a lender forgave some portion of a mortgage debt for which the borrower was personally liable (such as in so-called "short sales," foreclosures and "workouts"), the borrower was required to pay tax on the debt forgiven.
A law enacted in 2007 provided temporary relief to troubled borrowers when some portion of mortgage debt is forgiven and the mortgage covers the borrower's principal residence. That relief has expired and been extended several times. The latest extension provided relief for debt forgiven through December 31, 2016.
I am a real estate professional. What does this mean for my business?
Relief from the cancellation of indebtedness rules has facilitated the sale of homes in areas where home prices have declined or where foreclosures have occurred. In addition, providing tax relief would correct the unfair circumstance in which the only individuals who paid tax on the sale of a residence are fortunate sellers who have gains of more than $250,000/$500,000, and unfortunate sellers who have seen the value of their property decline to a level below what it is worth.
Short sale relief continues to be an urgent need for sellers in certain areas of the country where home prices still have not rebounded.
NAR supports an exclusion from taxation of the phantom income generated when all or a portion of a mortgage on a primary residence is forgiven.
There should be no taxable event when a lender forgives some portion of a debt in a short sale, foreclosure, bank workout or similar situation.
An individual or family that has incurred a loss on the sale of their principal residence has suffered what is, for most, the biggest economic loss of their lifetime. It is unreasonable and unfair to require that they also pay tax on the phantom income associated with debt cancellation, especially because there will be no cash proceeds from the sale.
Over the past several years, expiring tax provisions have often languished in Congress until after they expire. Most have been reinstated on a retroactive basis. However, with a great deal of attention now on tax reform, it is less certain that expiring tax provisions will be extended as a matter of course or on a timely basis. This is especially true since the enactment of the Protecting American Taxpayers From Tax Hikes Act in December 2015. This legislation extended some of the larger of the 50-plus expired provisions permanently, while others were extended for five years. Most others were extended only for two years, through 2016. The mortgage debt forgiveness provision was one of the two-year extensions. Thus, the provision expired on December 31, 2016.
While there is bipartisan interest in extending some of the tax provisions that expired at the end of 2016, including the mortgage debt tax relief provision, it is unclear when and whether these provisions will be acted upon. Congress has, over the past several years, gotten into a habit of allowing the expiring provisions to actually expire before acting on them, and then when they are extended, it has been on a retroactive basis. But with fewer large-scale provisions in the group of so-called “extenders,” most observers now believe that extending the remaining expiring provisions will be even harder than it has been in recent years. The fact that Congress will likely consider tax reform in 2017 also creates uncertainty about the outlook for the mortgage cancellation provision.
Nevertheless, this issue remains a high priority for NAR, which is actively encouraging Members of Congress to find consensus on extending this provision on a retroactive basis.
Federal Taxation Committee