The House Ways and Means Committee will consider tomorrow H.R. 3468, Download mortgage_loans_cancellation_of_debt_income. HR3468.billtext.pdf , to exclude discharge of indebtedness income in respect of a home mortgage loan.
The exclusion provision would be added as a new subparagraph (E) under the current section 108(a)(1) list of types of debt discharge that are excluded from gross income. The type of home mortgage loans excluded would be "qualified principal residence indebtedness" under section 163(h)(3)(B), without the application of subparagraph (ii). That provision defines a category of mortgage loan called "acquisition indebtedness" as a loan that is incurred to acquire, construct or substantially improve a "qualified residence" that secures the loan, where a "qualified residence" is either the taxpayer's principal residence or another residence (e.g., a second home or vacation home). For interest deduction purposes, the aggregate amount that can be treated as acquisition indebtedness is limited to $1,000,000, but for purposes of the discharge of indebtedness exclusion provision, that limitation would not apply. Accordingly, forgiveness of a multimillion dollar mortgage debt would be eligible for this exclusion.
I am still not persuaded that a broad provision like this is necessary. As I've said before, homeowners who lose their homes to foreclosures and face bankruptcy or insolvency are already protected by the existing provisions of the Code (section 108(a)(1)(A), (B). There is a group beyond those already insolvent that we might rightly want to protect--those whom we have failed to protect by adequately regulating credit providers who pressure them to take on high-interest loans beyond their capacity to pay and those who are struggling at the brink of insolvency to retain their homes and stay afloat in a difficult economy and weak job market. But this bill goes far beyond that. It will provide the most relief to taxpayers who are in neither of these categories-- e.g., to millionaires who have bought multi-million dollar vacation homes that they now realize are too big a debt burden or to taxpayers who have expensive homes that they need to sell quickly in order to facilitate their career move to another locale. To the extent they can talk the bank into taking a below mortgage amount (a so-called "short sale"), this bill would relieve them of any obligation to pay taxes on the benefit they received from the initial mortgage of which they are now relieved, even when they are fully able to pay.
I understand that many people think of debt relief as "phantom" income. If they used the loan to buy a piece of property, they don't think of themselves as ever having the cash, just the property. And if the property has gone down in value since its purchase, they feel like they got a raw deal already and tax liabilities for debt discharge just add to the rawness of the deal. But then why are we elevating this debt relief to the level of meriting a particular tax law provision providing relief, rather than debt relief connected with major health expenditures or debt relief connected with large education loans or similarly valued societal needs that are often funded with debt that often cannot be repaid? Is it just because of the current housing crunch? Or the vocal realtor lobbies? Or is the pervasiveness of housing debt simply a more pressing problem than the pervasiveness of catastrophic medical bills?
I also wonder if anyone has thought through the corollaries of passing this bill. After all, one of the loud supporters of some such legislation is the National Association of Realtors, whose numbers increased during the housing boom but have already started decreasing during the current bust. One suspects that realtors think this bill will help their business by making homes sell more easily at lower, below-mortgage prices. That may be good for the country--people will buy the housing they need at a lower price, and realtors will continue to get their commission on the deal. Or will this provision, as a permanent part of the Code, have a perverse effect on the housing bubble by encouraging taxpayers to purchase higher-priced homes, because of their knowledge that this tax liability won't apply if they should eventually succeed in having their lender write off part of the debt? Will lenders tend to provide credit more freely than they should under the assumption that this provision eases the way for debtors who ultimately cannot pay and thereby relieves pressure that might otherwise apply to them for having lent too freely for the loans that do go sour? ( Note that loosely regulated credit markets are a factor in the bursting housing bubble that has caused the concern about tax liabilities for discharged debt on written off mortgage loans.) I don't have a crystal ball, but sometimes, just sometimes, I wish I did.....
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