Senators press for tax relief on principal reductions, short sales

A group of senators are pressing Majority Leader Harry Reid, D-Nev., to allow a vote on a package of tax relief extensions set to expire this year, including a break for mortgage principal forgiven in loan modifications or short sales.

Homeowners who receive a principal reduction or a short sale next year will be required to pay taxes on the debt forgiven if Congress does not extend the Mortgage Debt Relief Act of 2007. The law expires Dec. 31. Up to $2 million of reduced debt can be excluded from taxable income under an extender package to be introduced in the Senate early next week.

The Senate Finance Committee passed the Family and Business Tax Cut Certainty Act, which would extend the tax relief through 2013, by a 19-5 bipartisan vote earlier in the month. (Read a summary of the bill here).

“It just depends on when Mr. Reid will schedule a vote on the package,” a Senate Republican aide said.

Democrats said they will make the push as well for the package to be passed when Congress reconvenes next month.

“These tax cuts will reassure families, help spur job growth and boost the economy,” Sen. Max Baucus, D-Mont., chairman of the finance committee said after the package passed earlier in the month.

The extension for providing relief on the mortgage debt reductions could cost $1.3 billion in lost revenue, according to an analysis of the bill.

But Baucus added it was an example of what Congress needs to do in order to avoid a looming “fiscal cliff” and solve a larger fight over extending the Bush era tax cuts for the rich.

Congress is also considering several programs to reduce principal for the roughly 11 million borrowers who owe more on their mortgage than their house is worth. Those programs would be rendered even less effective if borrowers elect not to take the relief in order avoid paying taxes on the assistance.

The $25 billion settlement between the five largest mortgage servicers and the state attorneys general earlier this year will provide some principal reduction next year along with expanded incentives from the Home Affordable Modification Program.

Mortgage bond analysts at JPMorgan Chase (JPM) expect roughly 650,000 short sales by the end of 2012, which may only increase as these types of liquidations become more popular.

Fannie Mae and Freddie Mac will ease rules beginning Nov. 1 to speed up the short sale process on the loans they guarantee, even for borrowers still current on their mortgage. 

According to Morgan Stanley (MS) research, short sales took up a larger percentage of distressed sales than REO earlier in the year. (Click on the graph below to expand.)

Banks and mortgage servicers have even begun sending large incentive payments directly to the borrower in order to ease the move after a short sale. But unless Congress acts on the extender package, those checks may be going to the government instead.

3d rendering of a row of luxury townhouses along a street

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