Mortgage tax break expires despite bipartisan support in Congress

WASHINGTON — A 6-year-old tax break for struggling homeowners who won reductions in their mortgages has expired, alarming housing advocates and lawmakers who said it still was needed despite the real estate market rebound.

Enacted by Congress in the wake of the subprime housing market crash, the break gave homeowners a free pass on taxes they otherwise would owe for aid they received from banks, basically reductions in mortgage debt and so-called short sales.

As much as $2 million in forgiven debt for each household was exempted from federal taxes under the 2007 law. The law expired at midnight Tuesday because lawmakers went home for the holidays without extending it — despite bipartisan support.

“It’s a hit on people who are meant to be helped,” Kevin Stein, associate director of the California Reinvestment Coalition, a housing advocacy group, said of the law’s expiration. “It is a big deal and it would be very unfortunate if, due to Congress’ inability to act, people will suffer.”


Stein and other housing advocates noted that about 6.4 million homeowners still are underwater on their mortgages, meaning that they owe more on the loan than the property is worth. Those borrowers could be helped by aid from banks.

And a record $13-billion settlement reached in November between the government and JPMorgan Chase & Co. to settle allegations that JPMorgan sold toxic mortgage-backed securities calls for the bank to provide $4 billion in principal reductions and other aid to homeowners.

Pending legislation in the House and Senate would extend the tax break through 2015.

Lawmakers are expected to take up the issue as soon as next week when they consider extending dozens of other tax provisions that expired at year’s end, such as deductions for corporate research and development. An extension of the mortgage forgiveness tax break could be passed retroactively, as was done last year.


Some Californians won’t face higher taxes no matter what Congress does. That’s because a state law enacted in 2010 shields homeowners from paying taxes on any benefit from a short sale, in which a home is sold for less than what is owed on the loan.

In a September letter to Sen. Barbara Boxer (D-Calif.), the Internal Revenue Service said the California law means that mortgage debt forgiven as part of a lender-approved short sale is not taxable income.

But Stein noted the state law does not apply to mortgages modified when lenders forgive part of the principal owed, enabling borrowers to stay in their homes. Homeowners who win such loan modifications would be hurt by the federal law’s expiration.

Principal reductions were a key part of a $25-billion settlement last year with large banks accused of foreclosure abuse by federal and state authorities. Most of that aid already has been disbursed.


Of about 187,000 California homeowners who received relief from the banks as part of the settlement through June 30, the most recent data available, nearly half got part of the principal forgiven on first or second mortgages. There were about 66,000 short sales under the settlement.

The average amount of mortgage relief to state homeowners who got help through the settlement was $108,000. Those who completed modifications and short sales in 2013 still will get the tax break; the expiration affects all new principal reductions.

California Atty. Gen. Kamala D. Harris was among 42 state attorneys general who sent a letter to congressional leaders in December urging them to extend the mortgage debt forgiveness tax break.

The attorneys general noted that the financial assistance from the mortgage settlement and other programs to assist consumers “will be less meaningful if the very homeowners that receive mortgage debt relief are hit with tax bills they cannot afford.”


According to the Congressional Research Service, a middle-income homeowner whose loan was restructured so that $20,000 of debt was forgiven would face a $5,600 tax bill if the law is not extended.

“It makes absolutely no sense. It is, frankly, outrageous,” Sen. Debbie Stabenow (D-Mich.), a leading supporter of the break, told her colleagues in December. “This is not just about fairness for homeowners. This is about keeping the housing recovery alive.”

The extension is backed by major players in the housing industry, including the National Assn. of Realtors and the Mortgage Bankers Assn., as well as dozens of consumer groups and housing advocates, such as the National Consumer Law Center.

Some Republicans and conservative activists question whether the government needs to continue expensive financial assistance now that the economy is recovering. The break originally was supposed to last only through 2010 and cost the federal government about $1.34 billion in lost tax revenue.


In the midst of the financial crisis in October 2008, Congress extended the break through 2012. Last January, the provision was extended again through 2013 as part of the deal to avoid the so-called fiscal cliff combination of large tax hikes and spending cuts.

“There is fatigue in Washington about government support for housing,” said Jaret Seiberg, a senior policy analyst at financial services firm Guggenheim Partners. “As a result, there is a real risk that the government will prematurely pull back support for housing.”

Still, he said there was a 60% chance Congress would extend the break and make it retroactive to Jan. 1.