Tax break on house, by House

In an eleventh-hour move, Congress passed legislation that could save many foreclosed homeowners tens of thousands of tax dollars.

The House on Tuesday approved by voice vote an amended version of the Mortgage Forgiveness Debt Relief Act. The bill will enable foreclosed homeowners to avoid owing federal income taxes on any debt that was forgiven when their home was seized and sold this year -- if President Bush signs it into law. Congress was expected to recess later Tuesday or today.

The Senate unanimously approved the bill Friday.

"By eliminating the foreclosure tax, we can eliminate one more concern faced by families already struggling to keep a roof over their heads," said Rep. Shelley Berkley, D-Nev., a member of the Ways and Means Committee, where the bill originated.

"By forgiving this tax liability, we will be helping those Americans who are suffering the most as a result of the downturn in the housing market and higher loan costs," Berkley said in a statement.

Senate Majority Leader Harry Reid, D-Nev., welcomed the House vote.

"For those who face foreclosure, the current tax rule is a cruel additional punishment. The bill heading to the President eliminates this tax penalty," a spokesman for the senator said in an e-mail.

Dennis Meservy, a certified public accountant and board member of the Nevada Society of Certified Public Accountants, had predicted a "nightmare" if the law had not been changed. The bill appears to be "a great fix," Meservy said. "That's great. That will help."

It is a particularly important piece of legislation for Nevada, which leads the nation in foreclosures. At the end of the third quarter, 2.15 percent of home mortgages in Nevada were in foreclosure, according to the Mortgage Bankers Association. The percentage of loans for which foreclosure started during the quarter climbed to 1.15 percent.

The new legislation will head off further problems for Americans who have been forced into foreclosure and had their credit rating damaged. The Internal Revenue Service can tax borrowers when lenders forgive some of their debt.

"When you borrowed the money, you were not required to include the loan proceeds in income because you had an obligation to repay the lender," according to an IRS report. "When that obligation is subsequently forgiven (by the lender), the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender."

As an example, an individual who borrows $10,000 and repays $2,000 may get the lender to cancel the remaining $8,000 obligation, the IRS report says.

That $8,000, however, is subject to income taxes, although the tax agency may not always pursue such cases. The lender must send the borrower a 1099-C form indicating $8,000 of the debt was forgiven.

The same sort of situation exists when a homeowner is foreclosed and owes more than the sales price.

That has happened to many Southern Nevada homeowners who bought houses during the peak of the housing boom with little or no down payment. In the wake of the housing market collapse, many of these homes are now worth less than the homeowner owes. On adjustable rate mortgages, the interest rates are starting rise, and many can no longer afford to make mortgage payments.

Some homeowners have persuaded lenders to let them to do short sales, in which a buyer pays less than the mortgage amount and the lender agrees not to pursue the borrower for the unpaid balance of the loan.

In other cases, the home has been foreclosed and sold for less than the loan amount. In both cases, a homeowner may find himself with additional taxable income because of the canceled debt.

Typically, foreclosed homeowners owe between $50,000 and $150,000 more than their house sells for, said Michele Johnson, CEO of Consumer Credit Counseling.

A taxpayer is in the 25 percent tax bracket could then owe $12,500 to $37,500 in additional taxes for 2007, Meservy said. Alternatively, the forgiven debt could push the taxpayer into a higher bracket, which would be 28 percent in this case, making the tax liability even higher.

Contact reporter John G. Edwards at jedwards@reviewjournal.com or (702) 383-0420.