Bankruptcy Can Protect Homeowners From Tax Forgiven Mortgage Debt (1)

Filing bankruptcy can be a last resort option for homeowners who have lost tax relief on mortgage debt they forgave after foreclosure or short sale of their home.

“If they’re suddenly faced with what could potentially be tens of thousands of dollars in IRS debt, that’s going to be an incentive to file for bankruptcy that might not otherwise be filed,” said Geoffry Walsh, attorney at National Consumer Law. Center that focuses on preventing foreclosures, consumer bankruptcy and other consumer credit issues.

For a decade before 2018, individuals who had mortgage debt canceled or canceled because they lost their primary residence to foreclosure or short sale could exclude up to $ 2 million of that amount. of their taxable income.

The provision expired at the end of 2017, along with dozens of other temporary tax breaks. And now, with the attention of Congress consumed by impeachment proceedings and other year-end priorities, hopes of renewing these short-term tax breaks are dwindling.

In the absence of this provision, taxpayers can potentially resort to tax breaks available under other parts of the tax code. People who are insolvent – that is, they have proven to the IRS that their liabilities exceed the value of their assets – or are bankrupt can exclude the canceled debt from their taxable income. This can save them from having to pay taxes on tens of thousands of dollars in additional income, if not more.

Taxpayers will need to consider whether the tax savings outweigh the disadvantages of these alternatives. In bankruptcy, for example, individuals risk losing some “non-exempt” assets that the court can sell to pay off creditors.

Timing is another important factor. Individuals must file for bankruptcy before tax is assessed because there are more complicated limits and rules for meeting tax debts, Walsh said. This opportunity may have already passed for taxpayers whose mortgage debt was forgiven or canceled and who were subject to a tax assessment in 2018.

Walsh noted that in bankruptcy, people pay more than just their mortgage debt. Thus, they could have other types of debt – credit card debt, medical debt, etc. – that they would otherwise have found a way to pay if it hadn’t been for the huge tax bill on their canceled mortgage debt, he said.

Renewing the tax break would be better for taxpayers, the justice system and the IRS than killing it permanently and pushing people into bankruptcy that otherwise wouldn’t happen, said Julia Gordon, president of National Community Stabilization Trust, which is working to restore vacant positions. and abandoned properties.

Reduction of tax relief

Lawmakers have paid less attention to tax relief in recent years than to other expired provisions with a stronger lobbying presence behind them – such as credits for the biodiesel and railroad industries. local interest.

The lack of urgency stems in part from the housing market rebound years after the financial crisis of the late 2000s. The tax break was first enacted in December 2007 to help taxpayers cope with the effects of this crisis.

But supporters of the provision note that many people still face challenges.

The National Association of Real Estate Agents in August 2019 report submitted to the Senate Finance Committee said there were more than 360,000 US homes in foreclosure last year, based on data from the Mortgage Bankers Association.

“While this number is significantly lower than the nearly 2 million homes foreclosed during the depth of the Great Recession, the current number is still surprisingly high given today’s strong economy and labor market. The group said.

The group recommended making the tax relief permanent at a reduced level and tightening the eligibility conditions. For example, NAR advocated the creation of restrictions to prevent borrowers who have not attempted to work with their lenders “responsibly” from taking advantage of the relief.

If permanence is not possible, the Realtors Group has proposed that Congress expand the provision in its current form.

According to a lobbying disclosure, the organization spent $ 8.2 million on lobbying in the third quarter, including S. 617, the Tax Extensions Bill, Senate Finance Committee Chairman Chuck Grassley (R-Iowa) and rank member Ron Wyden (D-Ore.), was introduced in February.

The number of taxpayers who claimed the exclusion in 2018 for the 2017 tax year was relatively small, but the dollar amounts were substantial.

According to IRS data, nearly 565,000 taxpayers have reported canceled debt income on their tax returns valued at a total of $ 6.25 billion.

About 148,000 people requested tax breaks on income from canceled debts, 15.5% of which were exclusions for forgiveness of mortgage debt on a principal residence. In total, this subset of taxpayers excluded about $ 2 billion from their gross income. Data for the 2018 tax year is not yet available.

Some objections

Critics of extending the exclusion argue that the tax break encourages homeowners to be less responsible for meeting their debts, said Ray Beeman, director and co-chair of the Ernst & Young firm of the Washington Council Ernst & Young of Ernst & Young LLP.

They say it causes people who pay their mortgages to receive worse treatment than those who don’t, said Beeman, who is also a former tax adviser to the House Ways and Means Committee.

Despite criticism, the tax break is unlikely to meet strong opposition from lawmakers. Still, action on expired extenders is part of larger negotiations.

“I don’t think there are a lot of lawmakers against this,” said Dustin Stamper, managing director of the Washington National Tax Office at Grant Thornton LLP and responsible for his tax legislative affairs practice. “It’s more about extenders in general and the fact that it has been difficult to pass legislation.”

Beeman said he was less optimistic than in the past that Congress will pass an extender bill. The idea of ​​dealing with those provisions in a substantial way – removing some and making others permanent – has died out, he said.

Grassley blamed Congressional Democrats, saying they had shown little interest in working on extenders.

Sen. Robert Menendez (DN.J.), a member of the tax drafting committee, said Democrats were ready to work on passing the temporary tax provisions, but Republicans want to include fixes to the 2017 tax law without offering anything significant in return. .

It is possible that the tax relief for the canceled mortgage debt could be part of a “meager” extension bill, Menendez said.

“I hope it can be. But I have the feeling that the president is holding everything hostage, ”he said.

A spokesperson for Wyden (D-Ore.) Said the senator supported extending the exclusion for homeowners and that it would be considered part of the negotiations.

The future credit legislation might be the best solution to extend the temporary tax provisions. But if lawmakers put in place a short-term, interim solution to funding the government beyond November 21, the tax benefits that expired at the end of 2017 will be more than two years old by the next funding deadline.

“The further you move away from the year in which people are actually claiming the credits, the less momentum there will be,” Stamper said.

– With the help of Kaustuv Basu.

About Marc Womack

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