The Mortgage Debt Relief Act (MDRA) of 2007 is getting a vote of confidence from the Obama Administration.
And that could save you tens of thousands of dollars.
The administration’s 2013 national budget proposal includes a provision to extend MDRA through 2014 and perhaps beyond.
You remember the MDRA? Real estate professionals and consumer advocates have been warning those who could benefit from MDRA to get their qualifying real estate transactions in gear because the MDRA, a mortgage debt-forgiveness tax exclusion is currently due to expire this year.
MDRA is a federal tax law that allows qualified taxpayers to exclude from taxation, income derived from the forgiveness or discharge of debt associated with a mortgage on a principle residence.
In a short sale, the difference between the amount owed on the mortgage and the amount of the sale, can be considered income. A short sale occurs when a lender agrees to write off – forgives or discharges – a portion of your mortgage, typically a portion that is higher than the value of your home, provided a capable buyer is available.
Robert Aldana, a 25-year real estate veteran and publisher of “LetsTalkRealEstate.com,” offers this example:
Let’s say you borrowed $500,000 for a home and later sell it as a short sale or lose it in foreclosure, but the lender gets only $200,000 and doesn’t come after you for the difference (in some states, including California, the lender can’t come after you for the difference in a short sale). You gained $300,000 because you borrowed that amount without having to pay it back.
If you are in the 35 percent tax bracket, then you would owe the IRS a whopping $105,000. Only in the 15 percent or so bracket? You would still owe $45,000.
Likewise, in a mortgage modification or other mortgage restructuring that includes a principal reduction, the amount of the reduction can be considered taxable income.
This year, Aldana and others have chided homeowners considering a short sale, mortgage modification or other workout that will come with forgiven debt, to get a move on. Those transactions can take time, lasting as much as a year and cause them to lose the exclusion, currently scheduled to expire at the end of 2012.
And the budget proposal, right now, is just that.
“Five to six months can be the norm, but there are some exceptions to the rule and you never know how long a short sale will take. I’ve witnessed short sales taking more than a year to complete,” Aldana writes.
MDRA has allowed struggling homeowners to unload a tax burden under certain circumstances.
• The exclusion applies to up to $2 million ($1 million if married and filing separately) in forgiven debt for calendars years 2007 through 2012, but only if the forgiven debt is related to a decline in the home’s value or the taxpayer’s financial situation.
• The exclusion applies only to the debt on the principal residence. Vacation homes, investment properties and other second homes don’t qualify.
• The tax rule can be applied to debt used to refinance your home, provided the principal balance of the old mortgage, immediately before the refinancing, would have qualified.
On Page 22 of “General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals,” the “Extend Exclusion From Income For Cancellation Of Certain Home Mortgage Debt” section explains the proposal for an extension on MDRA as necessary in the continued housing crisis.
Despite the many government-backed and private-based mortgage relief programs, millions of homeowners still face foreclosure and, because many have a mortgage that’s larger than the value of their home, they may have to have debt discharged.
The tax exemption helps foster short sales and modifications that might not otherwise occur because the already struggling homeowner would see a tax on the added income as a prohibitive cost.
The budget provision proposals reads: “Facilitating home mortgage modifications remains important for the continued recovery of the residential real estate market. The importance is demonstrated by the fact that HAMP (Home Affordable Modification Program) has been extended through the end of 2013.”
Likewise the Obama Administration, over time, has added improvements to the Home Affordable Refinance Program (HARP) to make it available to more home owners.
Extending MDRA through 2014 may not be the end of the rule.
“An extension beyond January 1, 2015, may be appropriate to correspond to the availability of additional homeowner relief as a result of government actions or other arrangements,” the proposal reads.