110th CONGRESS, LEGISLATIVE ISSUES A - Z

ISSUE: Congress has taken in keen interest in the housing market given the recent downturn in the industry. Home prices have fallen by 5% in many markets and are expected to eventually fall by at least 10%. Without legislative or industry action, as many as three million American mortgages loans are expected to default in the next two years. Two-thirds of these loans are expected to end up in foreclosure.

Some homeowners have more mortgage debt than their homes are worth, a situation that occurs when property values decline or because their downpayment was too small. As a result of the mortgage lending crisis and more specifically, homeowners who are unable to make their monthly mortgage payments, many lenders have increasingly negotiated with financially-stressed home mortgage holders, resulting in the cancellation of some debt (discharge of indebtedness). Most lenders would prefer to cancel a portion of a mortgage holder’s debt than to foreclose on the home and sell it at a deep discount at auction. However, when this discharge of indebtedness occurs, the homeowner is usually required to pay federal income tax on the cancelled debt. This makes such debt forgiveness less attractive, especially for individuals who can’t pay their mortgage debt, let alone the resulting tax bill. However, taxpayers who are bankrupt are usually exempt from such taxation.

When considering the federal tax implications of mortgage debt forgiveness, two types of income can be subject to taxation, the full or partial cancellation of mortgage debt and the gain from the sale of the home. For debt cancellation, the total amount forgiven is usually taxed as gross income. Lenders, such as credit unions, must report this action to the Internal Revenue Service (IRS) on a Form 1099-C. When the homeowner sells the home in excess of the original price (including improvements), a gain occurs that is also taxable. This also applies if the lender receives the home for the debt cancellation and the homeowner realizes a gain in the transaction. The IRS allows a tax exclusion for such gain up to $ 250,000 for individual taxpayers and $ 500,000 for married couples filing jointly. However, some conditions apply. It must be a primary residence owned and used for at least two of the previous five years by the taxpayer seeking the exclusion. Certain partial exclusions can apply in other circumstances.

To encourage debt cancellations, the Bush Administration and both the House of Representatives and the Senate took steps in 2007 toward making this process a nontaxable event for most filers.

CUNA POSITION: The Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) eliminated the requirement for most financial institutions (including credit unions) to file an IRS Form 1099-C (“Discharge of Indebtedness”) on a mortgage default involving an individual’s primary residence. CUNA supports efforts to increase the attractiveness of mortgage debt forgiveness when the borrower is permanently unable to pay his or her obligation. CUNA also supports the resulting decrease in tax reporting requirements. In addition, the new law makes permanent the tax deduction for private mortgage insurance for three years (until 12.31.2010), a provision that makes homeownership more affordable for credit union members.

STATUS/OUTLOOK: The Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) was signed into law by President Bush on December 20, 2007. The new law will allow most homeowners who obtained a mortgage before January 1, 2007 to receive mortgage forgiveness tax free. The law covers restructured mortgage agreements entered into after January 1, 2007 and before December 31, 2009. The tax forgiveness is available on mortgage indebtedness of up to $1 million. Also, the tax deduction for private mortgage insurance is extended for three years. Finally, the new law gives widow(er)s a two-year grace period before they lose the full $500,000 capital gains tax break that married couples currently enjoy on the sale of a qualified home. Under current law, the home must be sold in the same year as the death in order to avoid losing the full exemption.

CUNA’s analysis of other legislative and Administration proposals to mitigate the effects of the subprime mortgage crisis can be accessed by clicking on the following links:

• Federal Housing Administration (FHA) Reform
• Government Sponsored Enterprises (GSE) Reform
• Subprime Mortgage Lending Legislation
• Subprime Mortgage Bankruptcy Legislation
• Federal Reserve's Proposed Regulation Z Amendments

CUNA will continue to closely monitor this rapidly changing situation to ensure that credit unions retain the ability to provide safe and affordable mortgage products to their members.

CONTACT: John Hildreth, (202) 508-6724, jhildreth@cuna.coop

Copyright © 2009 - Credit Union National Association, Inc.