The Bush tax cuts are coming to an end, and Capitol Hill is abuzz with talks about how to deal with their demise. Real estate and mortgage industry professionals are naturally worried about the possibility of the mortgage interest tax deduction going away next year, but there is yet another tax break tied to the housing market recovery that is coming to an end in late December: The Mortgage Forgiveness Debt Relief Act and Debt Cancellation of 2007.
The Mortgage Debt Relief Act is not an original provision of the legendary Bush-era tax breaks. It was enacted at a time when the U.S. housing bubble had already burst. Before the law was passed, wiping out mortgage debt was considered income to the borrower, and therefore subject to taxation. This includes mortgage obligations discharged through the process of foreclosures, short sales and even principal write downs.
Both Democrats and Republicans in Congress would like to see the Mortgage Debt Relief Act extended past the end of 2012, but negotiations are currently stalled due to the fiscal cliff taking center stage.
Why Mortgage Debt Forgiveness Matters
The modest recovery of the U.S. housing market began once banks began to relax their stance with regard to short sales. Foreclosure rescue initiatives like the government-sponsored Home Affordable Refinance Program (HARP) have not done enough to stimulate the market, but the principle write downs mandated by the National Mortgage Foreclosure Settlement Agreement earlier this year have been very helpful.
The rationale behind extending the Mortgage Debt Relief Act is that borrowers and homeowners would not be so willing to participate in short sales or accept principal write downs if they knew that they would be stuck with a tax bill. Some observers worry that if this law is allowed to expire along with the mortgage interest tax deduction, many homeowners will simply give up trying to hold on to their homes.
Another factor contributing to the recovery of the housing market is that foreclosures are not taking place at the accelerated pace observed from 2009 to 2011. This in turn encourages borrowers who are underwater on their mortgages, but not delinquent, to stay in their homes. They need at least tax incentives to hold on tight, otherwise they are bound to give up and walk away from their mortgages.