Congress to consider extending Mortgage Debt Relief Act, renewing mortgage insurance tax deduction

taxshelter

When U.S. Congress reconvenes today on Capital Hill, the Mortgage Debt Relief Act (MDRA) of 2007 will be on the docket for a shot at an extension through 2013.

Editor’s note: Update: Congress passes fiscal cliff bill with mortgage debt forgiveness tax relief, home-related tax benefits intact

The law, officially called the “Mortgage Forgiveness Debt Relief Act,” could come with a resurrection of the mortgage insurance tax deduction, which would benefit even more mortgage consumers than MDRA. The deduction expired in 2011.

Due to expire Dec. 31, 2012, 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 principle residence.

MDRA has allowed struggling homeowners to unload this tax burden under certain circumstances.

  • It 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 due to 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, or you have documented receipts showing cash-out refinance funds were used for home improvements.

“The potential expiration of the Mortgage Forgiveness Debt Relief Act is doing very little to motivate delinquent homeowners to take action. Apparently, delinquent homeowners who are not paying for their monthly housing expense (strategic defaulters) are finding this savings outweighs potential tax liability consequences,” said short sale specialist Joy Bender, a Rancho Santa Fe, CA-based real estate agent with Prudential California Realty Dalzell Real Estate Group.

“However, some strategic defaulters who have assets would not qualify for insolvency and should have a strong motivation to sell immediately,” using a short sale if possible, Bender added.

Power of MDRA

The MDRA provision has been a major windfall in the recovering housing market, especially for underwater homeowners who’ve been able to skirt foreclosure by selling their home through a short sale – which typically involves forgiven debt, sometimes in the tens of thousands of dollars or more.

Also, a large share of the initial relief efforts made by lenders through the $25 billion National Mortgage Settlement signed earlier this year have been through short sales.

Short sales also have comprised a growing share of all homes for sale. In California, for example, one in five of all resold properties in July were short sales, according to DQNews.

“The groundswell of support for short sales from lenders, servicers, and government entities has been a boon for thousands of distressed homeowners with no other apparent way out. The extension of debt forgiveness, combined with current lender incentives and new guidelines allowing more borrowers to participate in the short sale process, have proven to be a strong prescription to assist our clients,” said Los Angeles, CA-based I Short Sale executive vice president Raffi Tal.

A provision for extending MDRA has languished since February in President Obama’s budget.

On Aug. 2, the Senate Finance Committee approved a bipartisan bill that would extend the MDRA through 2013, thanks to heavy lobbying from the National Association of Realtors (NAR) and the National Association of Home Builders (NAHB), as well as consumer advocates.

It could come up for a Senate vote in the next few weeks. If the measure doesn’t pass, it’s probably already too late for many who would benefit from the tax exclusion.

“Considering that most short sales take approximately 60 to 90 days to approve and then the buyer must complete their contract due diligence and close (typically another 30 days), homeowners are already at risk if they are just beginning the short sale process,” said Andrew Arild, a short sale and investment broker with the Los Gatos, CA-based Pertria real estate investment firm.

Mortgage insurance tax deduction

An extension of MDRA, possibly due for full Senate action this month, will include a retroactive extension of the mortgage insurance tax deduction provision, which became an MDRA provision in 2008, a year after it was originally added to the tax code. If passed, MDRA could also continue some energy-efficiency tax credits for remodeling and new home construction.

Mortgage insurance is paid by borrowers who come to market with a down payment smaller than 20 percent. The insurance protects the lender from borrowers defaulting. Borrowers who put less than 20 percent down are more likely to default on their mortgage than borrowers who have a larger stake in the purchase, studies have shown.

The previous mortgage insurance tax deduction allowed taxpayers with adjusted gross incomes of no more than $100,000 ($50,000 for separate returns) to write off mortgage insurance for the 2007 to 2011 tax years. The new version would allow the same or similar provisions for 2012 and 2013 tax years.

Exclusion, deduction impact

While the debt forgiveness portion saves individual consumers more cash on a given tax return, the deduction would impact more consumers, given the sheer number of home buyers who paid less than 20 percent down when they purchased their home.

Throwing a wrench into hopes for an extension of both provisions, of course, is the pending national election in November and ongoing partisan bickering at the expense of housing consumers.

“While there has been some activity regarding extending this protection, federal revenue enhancement has been a significant component of the disagreements between the parties vying to be in executive power after this November election. It would not be a surprise if MDRA became entangled in this process,” Arild said.

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