Homeowners could end up socked with big tax bills next year if Congress fails to renew two important tax breaks or tampers with the mortgage interest deduction as it grapples with the fiscal cliff this month.
Three tax provisions popular with homeowners are at risk.
The Mortgage Forgiveness Debt Relief Act says homeowners don’t have to pay federal income tax on the money that a lender forgives as part of a short sale, principal reduction or foreclosure. The exemption is set to expire at the end of the year.
The private mortgage insurance (PMI) deduction lets you write off the cost of the insurance you likely had to buy if you put down less than 20% when you bought your home. It’s a deduction that expires annually, but Congress has typically renewed it in the first quarter of the following year. That hasn't happened in 2012.
The mortgage interest deduction lets many homeowners deduct the cost of mortgage interest.
While all three of those tax breaks are a big deal to homeowners, they’re relatively small potatoes to budget negotiators, who are focusing on the bigger tax issues as they attempt to reach a compromise before the end of the year to avoid going over the fiscal cliff.
|State of loan||Value|
|Delinquent 30+ days||3.5 million|
|Foreclosure pre-sale||1.8 million|
|Delinquency rate||7.03% of homes||Source: Lender Processing Services, November 2012|
Homeowners aren’t the only ones who want the tax provisions renewed.
The attorneys general of 42 states have asked Congress to renew the forgiven debt exemption, so distressed homeowners are not stuck with an unexpected tax bill or deterred from participating in the $26 billion foreclosure settlement the group worked out with five of the nation’s biggest lenders.
With millions of homeowners delinquent on their loans or in foreclosure proceedings, the loss of this exemption could be a big deal.
National Association of Realtors President Gary Thomas says taxing homeowners on forgiven debt is really asking people to pay tax on income they didn’t get using money they don’t have.
"It is unfair to tax people on a phantom income, particularly at the time they have experienced an economic loss and probably have no cash with which to pay the tax," he argues.
The debt forgiven by a short sale can be significant, running into hundreds of thousands of dollars. And even for a family in the lowest tax bracket, the income tax on that much income would be a significant amount of money.
The PMI deduction has more modest tax benefits, which also begin to phase out with adjusted gross incomes of more than $100,000.
There’s also been talk, but no action taken, about eliminating or restricting the mortgage interest deduction as a way to help narrow the federal budget deficit.
It’s a popular deduction for middle-income homeowners who itemize deductions and among younger home buyers who are most often in the early years of their mortgage when interest payments are highest.
It’s unlikely that Congress would risk alienating middle-income homeowners by completely eliminating the mortgage interest deduction. It’s possible that the deduction would be reduced or limited in some way, perhaps by limiting its use by couples earning more than $250,000.