Take note, Southern Nevadans: If you own one of the estimated 100,000 homes that experts predict will be lost to foreclosure before the protracted housing crisis comes to an end, you may see a massive tax hike this time next year.
A law that has waived homeowners’ tax liability for any mortgage debt that was forgiven through modified loans, short sales or foreclosures is expiring at the end of 2012. If Congress doesn’t vote for an extension this year, forgiven debt will again be taxed as regular income — just as it was before 2007, when the provision was passed after the housing bubble burst.
In the past four years, the law has waived the tax liability for tens of billions of dollars in forgiven mortgage debt, saving families who are either severely underwater on their mortgages or have lost their homes tens or even hundreds of thousands of dollars in taxes they would have otherwise owed the federal government.
To the congressional delegation from Nevada, the hardest hit and most foreclosure-ridden state in the nation, extending the provision seems a no-brainer, at least in concept.
But even though the expiration date is months away, some lawmakers are bracing for an uphill battle.
The main fight in Congress this year is over how to balance the federal budget, or at least reduce deficit spending. The constant partisan back-and-forth over how best to do that essentially boils down to two options: cut more or tax more.
But also in the mix is a third option: getting rid of tax loopholes.
To the Democrats, that means eliminating subsidies for the oil and gas industries and eliminating tax write-offs for luxury items. To some Republicans, waiving taxes for forgiven debt for foreclosed homeowners looks like a tax giveaway, experts say.
“There are many on both sides of the aisle who believe ... the way to (bring the debt down) is to get rid of special-interest earmarks in the tax code. And for some, this is how this will be presented,” said Douglas Holtz-Eakin, former director of the Congressional Budget Office, who now heads up the conservative-leaning American Action Forum.
He said last week that he expects Republican House freshmen affiliated with the Tea Party to sound the loudest alarm on “tax-code ‘bailouts’.”
(For proponents of extending the tax waiver on forgiven debt, it probably doesn’t help that the provision, initially adopted in 2007, was extended through 2012 as part of the same bill that orchestrated the bank bailout.)
“Past this year, if you start doing tax reform, that reform is about getting rid of all sorts of special provisions,” he said.
Not all Republicans see the tax waiver as an extension of free money to troubled homeowners. Nevada’s Republican lawmakers expressed support for extending the program.
A spokesman for Rep. Joe Heck said he is in favor of an extension.
Staffers for Rep. Mark Amodei called the tax waiver “a good program” that should be extended as long as lawmakers could find money elsewhere in the budget to offset the $2.7 billion the federal government won’t be collecting over a two-year extension of the program.
Sen. Dean Heller said Monday that he couldn’t see how it made sense “to tax income people have never seen,” as would be the case if the program were allowed to expire.
But the opinions of Nevada’s Republicans may not matter as much as the opinion of one Republican from Ohio: House Speaker John Boehner.
In 2007, when lawmakers last went on record about this program, Boehner was one of just 27 lawmakers — all Republicans — who voted against the Mortgage Forgiveness Debt Relief Act, as it was named. (Heller, Rep. Shelley Berkley, and Sen. Harry Reid, the only current members of the Nevada delegation who were representatives in 2007, all supported it.)
Boehner’s district in Ohio hasn’t been as hard-hit as Southern Nevada. But Boehner was joined in that “nay” vote by four House members representing four of the top 10 congressional districts hardest hit by foreclosures at the peak of the crisis.
The House speaker hasn’t made any moves to extend the tax waiver. But some Democrats, led by House Ways and Means Committee members Jim McDermott of Washington and John Larson of Connecticut, are circulating a bill called the Tax Relief for Veterans and Homeowners Act.
The bill was presented to lawmakers in a letter that began circulating in Congress on Feb. 10, one day after the federal government and 49 state attorneys general struck a $25 billion settlement deal with the country’s five biggest mortgage banks.
"Unfortunately, our existing tax law would treat much of this relief as income that homeowners would have to pay tax on,” McDermott and Larson’s letter reads.
Their bill extends the Mortgage Forgiveness Debt Relief Act provisions for all principal reductions for three years and gives special consideration to veterans who were wrongfully foreclosed on.
Berkley, who is on the Ways and Means Committee and co-chairwoman of a special Democrats’ task force on housing, is expected to co-sponsor the legislation.
While a potential legislative vehicle hasn’t yet emerged in the Senate, Reid is expected to push for an extension, possibly as part of the lame-duck tax bill many are anticipating will dominate the postelection agenda of 2012.
But it could come sooner: President Barack Obama called for an extension of mortgage forgiveness tax relief in his fiscal 2013 budget — and fiscal 2013 starts Oct. 1 this year.
The big question, however, is what might happen in the interim, as homeowners sitting on distressed properties watch Congress and wonder whether lawmakers will be able to pass an extension before it’s too late.
“Even the uncertainty related to passage of the bill can quickly hold back economic recovery,” said Lawrence Yun, chief economist for the National Association of Realtors, which strongly backs an extension of the tax relief for forgiven mortgage debt.
“If people have to plan to pay taxes on debt forgiveness, then they will quickly retrench to say they cannot go out and spend, because they need to save money for this unknown tax amount that may be out there,” Yun continued. “In terms of the economic impact, disproportionally, places like Nevada and Florida will be much more affected.”
The taxes that would be levied on forgiven debt, counted as extra income, are a one-shot deal: Just as taxes are applied to income in the year that it is earned, forgiven debt would only be taxed in the year it was received through a principal reduction, foreclosure or short sale.
A worst-case scenario could also be a modest run on the housing market in the next 10 months as owners of distressed properties try to dump them before the end of the year.
“If, say, there’s an added rush to bring properties onto the market(for example, speeding along a short sale), added supply always means lower prices, so the lower prices would hamper this housing recovery,” Yun added. “Honestly it depends on whether or not there are buyers able to absorb all of this supply coming onto the market.”
A more likely impact from the uncertainty could be the Obama administration’s push for mortgage modification.
While underwater homeowners have been begging for banks to reduce the principal on their loans, homeowners may instead opt for less-aggressive mortgage modifications that won’t leave them with a tax burden in the year ahead.
Mortgage Forgiveness Debt Relief can be applied to up to $2 million in forgiven debt that would otherwise be taxed (about $700,000 in taxes, at the applicable 35 percent rate of taxation). Most distressed homeowners’ mortgages are not that big, but without an extension of the tax break the impact can still be dramatic.
“People want to get mortgages modified, but (without the tax break) it suddenly changes the incentives for a homeowner,” Yun said.