A crucial tax break for underwater homeowners that expires in less than five weeks may get overlooked as Congress tries to tackle the so-called fiscal cliff, housing advocates fear. Failure to extend the break would result in devastating consequences for homeowners and the housing market, they say.
Homeowners who owe more on their mortgages than their homes are worth have benefited from the the Mortgage Forgiveness Debt Relief Act since 2007. The law exempts homeowners from having to pay federal taxes on the balance of their mortgages after a foreclosure or short sale.
The exemption expires Dec. 31. If Congress doesn't extend the tax break, many sellers and even borrowers who receive a loan reduction through a modification could be hit with huge tax bills in 2013.
"Sellers who are in the process of short selling are really worried,"says Patty Da Silva, a short-sale specialist and owner of Green Realty Properties in Davie, Fla. "They ask me: 'Have you heard any updates, have you heard anything?'"
Da Silva says one of her clients is selling her house for about $220,000 less than the balance of the mortgage. Without the tax exemption, her client could be liable for almost $50,000 in federal taxes, she says. That's because the Internal Revenue Service treats the "forgiven" amount as income even though the seller is not actually collecting any money at closing.
Tony Hutchinson, a senior policy representative at the National Association of Realtors, says Congress will likely extend the tax break as it works to avoid the fiscal cliff, but the uncertainty has already started to affect the housing market, he says.
"Our members are very worried about this because their clients are asking them whether they should place a short sale on the market or hold off until next year when there is more certainty," he says. "Keeping any properties off the market will retard our fledgling yet growing recovery."
If the law is not extended by the Dec. 31 deadline, Congress could still extend it in early 2013 and make the law retroactive. But that would still disrupt the market temporarily, he says.
"The issue is not the mechanics of the forgiveness but the perception," he says. "The key reason many want it extended is because if folks do not think it will be, they'll not short sell."
Last week, attorneys general in 43 states joined efforts and wrote a letter to Congress urging the extension of the legislation that provides the debt cancellation tax break.
"Each of our offices receives calls everyday from homeowners trying to save their homes or struggling to recover from losing their homes," the letter read. "Requiring a homeowner to pay income tax on forgiven or canceled mortgage debt would make the National Mortgage Settlement much less effective."
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