Cancellation of Mortgage Debt - Questions and Answers

There have been a lot of question regarding the Cancellation of Mortgage Debt Relief Bill and the Realtor.org has outlined some of the questions and answers in a recent article The full article can be viewed at http://www.realtor.org/subprime_lending.nsf/Pages/mort_cancellation_qna?OpenDocument

Here is a short synopsis of the article. To view the entire article click on the link above.

Has this law been passed?
No. The House of Representatives has passed a bill, but it needs the Senate's approval, and then the signature of the president.

Current Law: The cancellation of mortgage debt rules apply only to a limited number of taxpayers. The provision is best understood with an example.

Assume you purchased a home for $650,000 with a mortgage of $600,000. Now you need to sell the home, and values in the area have declined and you can sell for only $550,000.
At the time of the sale, the outstanding balance on a mortgage might be, for example, $569,000. In this scenario there will not be enough cash closing to repay the lender the full balance of the mortgage. In some limited circumstances, a lender might forgive the amount of the balance that exceeds the purchase price ($19,000 in this example).

What happens to the seller when a portion of mortgage debt is forgiven? Under current law, the amount of forgiven mortgage debt (the $19,000 in this example), is treated as income, and taxed at ordinary income rates. Thus, the seller, who has experienced a true economic loss, is required to pay tax on this phantom income, even though no cash has changed hands and even though he has experienced a loss.

What about a refinanced mortgage? As currently drafted the provision would apply to either an original or refinanced mortgage.

The provision would also apply to commercial real estate as well.

Why is the law being considered?

Historically real estate has appreciated in value. But as need in some markets recently values have declined. This may be due to an major employer leaving and area or a homeowner needs to sell in a down market due job relocation. It seems particularly unfair to tax phantom income at a time when a taxpayer is in reduced economic circumstances.

There are a lot of mixed feelings out there regarding this potential law. Some will say that the homeowners should have been more prudent when purchasing their home and not overspent. At the same time no could predict the timing for the change in the Real Estate market. What seemed like a great deal a couple of years ago might not look that way right now. This is obviously can be an emotional process for the homeowner if they are facing this situation and potentially a huge financial impact to the lenders who forgive the loans.

There is sure to be a lot of debate over this issue to come in the months to come. It will be interesting to see how the Senate and President react.