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Law Alert!

Congress Extends Mortgage Forgiveness Debt Relief Through 2013

(Posted January 11, 2013)

For updated information on this topic, see our more recent law alert.

The mortgage debt relief provisions for homeowners in the federal tax code, first enacted in 2007, expired at midnight on December 31, 2012. But the fiscal cliff bill enacted at the 13th hour by the Congress extended the relief through the end of 2013.

Because there are still huge numbers of financially distressed homeowners with underwater mortgages, this was one of the biggest issues in the fiscal cliff debate. Had Congress not acted, the tax code would have reverted to its pre-2007 treatment of mortgage principal reductions or cancellations by lenders, whether through loan modifications, short sales, deeds-in-lieu, or foreclosures.

That means that all principal balances unpaid by the homeowner and forgiven by the lender would have been treated as ordinary income to the homeowner. For example, if a lender wrote off $200,000 of mortgage debt to facilitate a loan modification or short sale, the borrower or seller would have been taxed on that $200,000 at regular marginal rates, just as if he or she had earned it as wages.

The Mortgage Forgiveness Debt Relief Act of 2007 (Pub L 110-142, 121 Stat 1803) and its extending amendment allowed exclusion of income realized as a result of debt reduction on the taxpayer's principal residence. See IRS, Ten Facts for Mortgage Debt Forgiveness (Mar. 3, 2011). See also IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (2011). Under the Act, taxpayers may exclude debt forgiven on their qualified principal residence up to $2 million ($1 million for a married person filing a separate return). IRC §§108(h)(2), 163(h)(3)(B)(ii). The law as originally enacted applied to debt forgiven in calendar years 2007, 2008, and 2009. Pub L 110-142, §2(a), (d), 121 Stat 1803. A 2008 amendment to the Act, applicable to discharges of indebtedness occurring on or after January 1, 2010, extended the Act through 2012. Pub L 110-343, Div A, Title III, §303, 122 Stat 3765. The fiscal cliff bill extended it through the calendar year 2013.

For further discussion of foreclosures, short sales, and loan modifications, see California Mortgages, Deeds of Trust, and Foreclosure Litigation, chaps 2, 7, and 10 (4th ed Cal CEB).

© The Regents of the University of California, 2013. Unauthorized use and/or duplication of this material without express and written permission is strictly prohibited.

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