Journalism in the Public Interest

Homeowners Who Negotiate Debt Relief Could Soon Face Massive Tax Bill

If Congress doesn’t renew a key 2007 law, people who get a principal reduction on their mortgages or short-sell their homes could be forced to pay taxes on their “gain.” 


A home for sale by its owner in Pleasant Prairie, Wis. (Scott Olson/Getty Images)

Feb. 23: This post has been updated.

You bought your house when the market was high and then lost your job. In order to avoid foreclosure, you negotiated a short sale for half of what you paid, ruining your credit rating for years and draining your bank account. But there is a tiny silver lining: Thanks to a 2007 law, you don't have to pay taxes on the $100,000 of debt your bank forgave as part of the short-sale agreement.

This week, real estate columnist Kenneth R. Harney pointed out that this important tax break will expire at the end of 2012 -- and, because of opposition from conservative members of Congress, might not be renewed.

The Mortgage Forgiveness Debt Relief Act of 2007 ensures that homeowners who restructure their mortgages or short-sell their homes don't have to pay taxes for reducing part of their debt.

Without the law, any cancelled debt typically counts as income. So an underwater homeowner who negotiated a principal reduction on her mortgage would have to pay taxes on that amount of "income."

The law creates an exemption for up to $2 million of forgiven debt on a taxpayer's primary residence.

Harney pointed out that the debt relief act provides a crucial underpinning to last month's $25 billion mortgage settlement, which requires five of the country's largest private loan servicers to provide $17 billion in principal reduction and other forms of foreclosure avoidance.

And given the importance of mortgage modifications and principal reductions to the Obama administration, you might think that the law would be on the fast-track towards further extension. (It was extended once before in 2008.)

But Harney reported that some conservative members of Congress may not approve of the program's $2.7 billion price tag, or of provisions they might perceive as a federal "bailout" of underwater homeowners.

"It's going to be an uphill fight" to get the law extended, economist Douglas Holtz-Eakin, a former McCain adviser, told Harney.

The debt forgiveness act originally had broad bipartisan support: It passed in the House of Representatives on a 386-to-27 vote. But among the Republicans who voted against the law in 2007 was now-Speaker of the House John Boehner. Boehner's office has not yet responded to a request for comment.

New York Democratic Congressman Charles Rangel, who sponsored the law, said that he plans to reintroduce it soon as part of this year's tax extender package.

"The issue for all the extenders is how we pay for them," Rangel said in an emailed statement. "While there may be resistance, this extension may very well be driven by public concern. Many of our nation's homeowners are still hurting from a housing crisis that has brought great financial instability and uncertainty -- they demand help and we must make sure their voices are heard."

The National Association of Realtors, which supported the original bill, is planning to make a "strong push" to get it re-extended.

"In light of how hard home owners were hit in the market downturn, it was unrealistic to expect households to pay tax on tens of thousands of dollars on forgiven debt when they lack money to pay their mortgage without a modification," Robert Freedman wrote on the association's Realtor Magazine blog.

In a video interview on the site, NAR's director of tax policy, Linda Goold, said there would be "very, very serious economic repercussions" if lenders and borrows remained uncertain about whether the law would be extended.

She said that the mortgage provision would be one of many tax laws expiring at the end of 2012, creating "an environment of remarkable chaos."

"Congress has always lumped the expiring conditions into one big package," Goold said. "That package has usually been, if not one of the very last things Congress did in December, pretty much close to the last thing Congress has done." She noted that it was unlikely that Congress would pass a single tax exemption separately from the others.

"It's the inability to get the process rolling that's our biggest obstacle," she said.

Catherine G. Tripp

Feb. 23, 2012, 2:24 p.m.

Even seasoned real estate practitioners are under the impression that mortgages on primary residences are all non-recourse – in other words, if selling the house doesn’t raise enough money to pay off all the mortgages, the lender has no recourse to any other recovery method.  This is NOT true.  California law offers some protection here, but according to the Code (Cal. Code Civ. Proc. Section 580b) it is limited to primary residence purchase money.  After reading the entire Deeds of Trust, for the “purchase money” loan (mortgages taken out at the time of purchase, not afterwards) and my most current loan, I could find nothing in the deeds barring recourse to the borrower.  The protection is not in the lending documents, it is in the State Law Codes.  Equity Lines and Second Trust Deeds are not mentioned in the California code.  If the lender decides to pursue a “deficiency judgment” for the difference between what was borrowed and what was collected, only the mortgages used to initially buy the owner’s primary residence are considered non-recourse debt.  That means the lender has recourse, meaning “permission to pursue” the borrower for the shortfall.  Right now, it appears that lenders are not engaging in this public relations nightmare, but the big black granite sculpture in the plaza of the former Bank of America building wasn’t dubbed The Banker’s Heart for nothing.

Catherine,  The problem is not if the loan is a recourse or non-recourse, it is how it is handled when you file your tax return for the year when you do a short sell or loose your house to foreclosure.  The IRS would be notified, from the bank, that you were “excused” debt in what ever amount they decided was “excused”,  and that then becomes income to you for that year.  Can you imagine adding $100,000 or more to your income come tax time???? This is an extreme hardship for people who already cannot afford their mortgages, have lost jobs or gotten sick and have major medical bills. I hope everyone remembers this as they go to the ballot box this year.  “Less Government” and “End the Fed” is what I say and you should vote for a candidate who also supports this position or we are all going to have one heck of a time going forward.

Catherine G. Tripp

Feb. 23, 2012, 3:23 p.m.

Laura, I agree it is egregious to charge taxes on a primary residence’s loss.  The comment was an excerpt from an article I wrote in 2010 for, about adding insult to injury - the possibility that only some of the debt will be forgiven (then taxed) becomes even worse considering that the portion unprotected by non-recourse laws might not be “forgiven” even after the house is foreclosed.  And kudos to Lois Beckett for reporting on this too-easily-missed story.

Y’know, I understand why it happens, but it has always seemed barbaric to me to call a forgiven debt (in the general sense) income.  The alternative is defaulting, which you would think we’d be incentivized to avoid.

Plus, if you couldn’t afford to pay the bills, you probably can’t afford the added tax, since the “income” didn’t actually arrive.

I hope ProPublica will continue to pursue updates on this….I think it is also imperative to include a point omitted in this story—-if people who MAKE money on selling their house are excluded from paying taxes on $500,000 of the gain (that’s for a married couple, 250k i think for singles—a provision that also discrimates against singles, btw, but that’s another issue) then why should someone who LOSES money—and likely their life savings/biggest asset - be taxed on it?  That is the biggest rebuttal to the Republicans who seek to not renew the provision…..makes no sense and also will force many more people to declare bankruptcy to get out of paying what the banks might come after them for (if they don’t ‘forgive’ the debt—that goes back to the recourse/non-recourse argument sited by reader above.) ironically, however, if the debt is reported to IRS by the bank, then bankruptcy wouldn’t get the homeowner out of paying the taxes owed. So it might be better strategy not to have the debt forgiven—and then just declare chapter 7 bankruptcy if possible….

Recognizing forgiven debt as income would likely obviate the benefit of the debt reduction by saddling borrowers with an incremental tax burden and pushing them further into financial hardship and perhaps make it likely they are unable to service there restructured mortgage. 

I will say however that I think the trend towards more and more government relief for borrowers is troubling.  Should the government perhaps provide some some borrowers with home equity lines in case they have trouble making the restructured payment?  At some point this all needs to be paid for.

“it is egregious to charge taxes on a primary residence’s loss”.


John Smith buys a house for $400k, borrows $250k and puts down $150k of AFTER TAX money.  The house value drops to $250k and he’s out $150k of real, after-tax money.

On the same day as John Smith buys his house, John Jones buys a $400k house next door, puts $0 down and borrows the whole $400k.  The house value drops to $250k and he short-sells it for $250k.  He gets a 1099 for the $150k of debt reduction and has to pay taxes on it - perhaps $60k of taxes.

So even WITH the tax obligation on debt forgiveness, John Jones only loses $60k, where John Smith lost $150k.  Jones is already doing much better than Smith, but that’s not good enough for the whiners?  How about the people who put money down?  When do THEY get some free money?  You get a bunch of debt forgiven and you don’t even want to pay 1/3 of the amount forgiven in taxes?

Iska Warren - - ace the difference is CASH - Tthe mortgaged property was sold and yielded no cash - to pay the tax - presumably if sold short they didnt have the ability to pay the mortgage anyway and now the situation is made a lot worse if there is a tax which is why it was waived

the party that has 100% equity “had” cash and lost it - he has no future liability - at least he can start fresh with a capital loss for future offset of income

corporations walk all the time without blow back - corporations are people as romney said -  human “people” should have the same advantages

further the banks committed FRAUD coast to coast - end to end - which is the reason for the short sale to begin with - systemic fraud produces markets that collapse -  given the unnatural event -  no one should pay other than the banks

Mortgage Forgiveness Debt Relief Act of 2007

It will only apply to foreclosed homes and those in the process, so why the big article? The most anybody will get is a stick in the eye and the thieving bankster makes off with a tithing from Obama’s idea of “forgiveness”. Screw that.

Those bassturds stole every down payment that was made on a home, from coast-to-coast. They pocketed the loot when they crashed the economy and got bailed out with our money. With most homeowners the equity of homes have plummeted and still they plummet, 25% to 30% or more. Life’s savings stolen by Wall Street and equity stolen by the banks. A beautiful thing for a carpet bagger.

Providing this kind of relief provides a benefits only those who aren’t paying their mortgages at the expense of the U.S. taxpayer.  I tend to think there are multiple parties at fault here with the banks playing a role but also borrowers as well. 

It is ridiculous to provide any sort of relief to borrowers who put no equity in their homes to begin with.  If you bought a house with nothing down and aren’t paying the mortgage now, the handouts shouldn’t extend to tax relief.

CDA = nonsense !

the borrowers didnt commit systemic fraud… the banks did !!! - end to end -  this is merely a way to keep the sheeple in line - and not bouncing off the walls -  rather than put the banksters in jail

its called social engineering nothing more

plenty of people had equity in their homes 25 to 40%  of PP - but the homes sold on short sale for 50% of PP so they have a equity loss which is deductible and the banks as well - compounding that with a tax in lieu of NO economic benefit to the taxpaying party - is crazy - not what the original provision was designed to capture -

contracts always break down when there is “fraudulent inducement” which is endemic in this current environment

do some homework and you wont be so self righteous !

start with googling BoA and the word FRAUD !


thank you! as a former realtor, i watched the unfolding of the “real estate crisis” with my jaw dropped. it was the lenders/mortgagers who were packaging and APPROVING these loans. they were bailed out by the fed, why not the people who were frauded?


Realtors were a significant contributor to the housing problem. I know of many cases when the market was rising and selling quickly where realtors wouldn’t even put listings in the MLS; they pocket listed the property so they could greedily get both sides of transactions. They wrote contracts for Buyers they knew really shouldn’t be buying properties, and then hounded Brokers and Lenders to get financing so they could line their own pockets. Lenders were stupid and greedy also, but a realtor coming here feigning innocence is absolutely hilarious and disengenuous.

As to the topic, in a fair world, only the cash out a Borrower received from a refinance should be subject to 1099-C “income.”

dave -

that is a distinction without merit in comparing systemic FRAUD by an underwriter   - and his affilates -  to an occasional realtor taking an opportunity

“lenders” werent stupid or greedy as you say - they were - CRIMINAL - big difference in language

i am not a realtor - but the current condition of systemic fraud by banks - end to end - are the “sole” reason for the decline in general real estate value beyond the cyclical effects of a recession

further this lady speaking as a realtor knowing of Fraud doesnt take away from the observation

if you feel compelled to support bank fraudsters i understand - many other people cant reconcile their complicity in the largest fraud in history and continuously offer excuses or diversion just like you

dave - if you need any more examples use google and the phrase “bank fraud”

Flagstar Bancorp Inc. has agreed to pay $133 million to settle claims its mortgage unit engaged in fraudulent lending practices.

The U.S. government said in a release Friday it filed and settled a civil lawsuit against the Troy-based holding company for Flagstar Bank. The government says the bank improperly approved residential home mortgage loans for government insurance.

“The lawsuit ... is another stark example of how certain lenders put profit ahead of responsibility by recklessly churning out mortgage loans without regard to the risk that those loans would default or the significant consequences for the individual homeowners who would inevitably default on their loans, the housing market, and in the aggregate, our nation’s economy,” U.S. Attorney Preet Bharara of the Southern District of New York said in a statement. “Flagstar has accepted responsibility for its conduct and committed to reform its business practices to ensure compliance with (federal) requirements.”

This policy only benefits people under water on their mortgages at the expense of taxpayers, not banks.

If you truely believe this is about bank fraud then you should advocate that the banking industry compensate all recent home buyers for loss in value of their homes, reagrdless of debt or equity financing.  Also, anyone who sold a house at the top should probably return proceeds and realtors shoud return their ill gotten commissions given values were all based on fraud top to bottom.

Yes, I know banks were bailed out by tax payer so why not the homeowner, but the banks are still on the hook to pay the taxpayer back and this makes no such concession (BofA did pay back the treasury last I heard). 

If the government is handing benefits due to systemtic fraud, then let’s all make sure we get a piece of it regrdless of if we are underwater on our mortgages or didn’t borrower more than we can return.  I want a a new GM car!

Richard Askenase, Attorney

Feb. 27, 2012, 10:35 a.m.

As a bankruptcy attorney, this lapsing of the tax avoidance will only help my practice.  While I don’t believe that a short sale is a good idea anyway (only the realtor makes money), this even further con firms the fallacy of short sales.  So let it go to forelcosure and file bankruptcy (7 or 13).  Then no tax probelms (discharge of debts in bankruptcy is NOT a taxable event).

Further, this will continue the downward pressure on real estate values and encourage more foreclosures.  I think that is what the conservatives want, anyway.  (It is sort of analgous to Romney’s let Detroit default arguement.)

As public policy, this lapsing is really stupid- but good for my Business.

CDA - you said - “If you truely believe this is about bank fraud”

this has nothing to do with “my” belief system it is about FACTS - again all you need to do is google - bank fraud -  from $1 million to $7 billion will come up in fines “to date” and settlements -  the largest to date being BoA -  outside of the latest $25-40 billion master settlement -  which is a joke -


properties “without” mortgages have been defrauded
properties with mortgages have been defrauded
properties with - mortgages -  “owned” by investors have defrauded

its called RACKETEERING !

RICO - was established thirty years ago to deal with this - originally for the five organized crime families which have morphed into the five banks today

ALL the parties mentioned above DESERVE compensation - i put forth the proposition that the property owners WITHOUT mortgages should be the most agreaved party since they are bystanders but their values have been affected by systemic bank practices to include / such as -  MERS title assignments that have been defective (Only 16% of assignments of mortgage are valid in one county - see below) -  thereby chilling the market and keeping people out who are concerned about good title -  and therefore the values have declined precipitously (read: greater than cyclical effect) all due to - several/ many - criminal bank practices - end to end -

the only way to effectively manage this whole debacle is to prosecute and convict - 5,000 bank executives at the five organized crime families / banks - and then plea bargain % royalty ON THE “BANKING” INDUSTRY (NOT JUST MORTGAGE INDUSTRY - ON THE FOUR DIGIT SIC CODE(S)) towards the compensation for ALL parties over the next 50 years.- just like the tobacco industry (when you have them by the gonads their hearts and minds will follow)

here is on representation of just ONE ASPECT of the problem and effect on values:

Register John O’Brien (Mass.) revealed the results of an independent audit of his registry. The audit, which is released as a legal affidavit was performed by McDonnell Property Analytics, examined assignments of mortgage recorded in the Essex Southern District Registry of Deeds issued to and from JPMorgan Chase Bank, Wells Fargo Bank, and Bank of America during 2010. In total, 565 assignments related to 473 unique mortgages were analyzed.

McDonnell’s Report includes the following key findings:

• Only 16% of assignments of mortgage are valid
• 75% of assignments of mortgage are invalid.
• 9% of assignments of mortgage are questionable
• 27% of the invalid assignments are fraudulent, 35% are “robo-signed” and 10% violate the Massachusetts Mortgage Fraud Statute.
• The identity of financial institutions that are current owners of the mortgages could only be determined for 287 out of 473 (60%)
• There are 683 missing assignments for the 287 traced mortgages, representing approximately $180,000 in lost recording fees per 1,000 mortgages whose current ownership can be traced.


This article is part of an ongoing investigation:
Foreclosure Crisis

Foreclosure Crisis: Banks and Government Fail Homeowners

Banks and the government have fallen short in helping homeowners in danger of foreclosure.

The Story So Far

Systemic failures at the country’s banks and mortgage servicers have exacerbated the most severe foreclosure crisis since the Great Depression, and government efforts to limit the damage have fallen short. ProPublica created an unrivaled database of homeowners who have faced foreclosure, opened a Facebook page to encourage homeowners to share their stories, wrote profiles of some of them, and incorporated their experiences into our reporting. We also provided a comprehensive rundown of the numbers behind the crisis.

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