The wrangling in Congress that has prevented a package of expired tax breaks from being reinstated threatens to slap massive tax bills on thousands of Americans who have given up their homes in “short sales,” a common practice after the 2008 real estate crash in which banks allow homes to be sold at lower prices than the amounts owed on the mortgages.
Without a renewed exemption, families would have to pay taxes on the forgiven mortgage debt as if it were income, although they merely avoided foreclosure and walked away from their homes without earning anything from the sales.
Supporters of the exemption say taxing the phantom income would only hurt Americans who suffered most from the Great Recession, people who resorted to short sales because they didn’t have enough money to make mortgage payments and simultaneously faced the plummeting values of their homes.
“No one gets hit more than low-income [and] middle-income families,” Sen. Dean Heller, Nevada Republican and a leader of the push to restore the tax break, said at a Senate Banking, Housing and Urban Affairs Committee hearing. “I just think it’s unfair and I think most would concur that it’s unfair that individuals would have to pay taxes on income that they have never received.”
More than 170,000 homes were sold in short sales in the U.S. from January through September this year, with an estimated $8.1 billion of mortgage debt forgiven, according to the latest data available from housing research and analytic firm RealtyTrac.
The typical short sale involved about $75,000 of forgiven mortgage debt, which could push even the poorest Americans into a 25-percent tax bracket with income tax bills of at least $18,750.
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The mortgage debt forgiveness exemption is one of several popular individual tax breaks caught in the political crossfire over the entire $85 billion package of so-called tax extenders, about 50 special-interest tax breaks that expired at the end of last year.
Other popular measures in the package include income tax deductions for teachers’ out-of-pocket expenses for school supplies, for college tuition and fees paid by students or parents, and for the cost of energy-efficiency improvements made to homes.
The hang-up is a couple of costly measures targeted at business interests. The more contentions is a tax credit for wind energy projects that would cost $13.3 billion if extended through next year. Critics also say the package contains frivolous tax giveaways such as depreciation for NASCAR race tracks that would cost $12 million and credits for Hollywood movies that would cost $380 million.
Lawmakers have been unwilling to divide the package of tax breaks into separate bills.
Negotiations are continuing, but lawmakers have begun raising doubts about their ability to strike a deal before the end of the year. After that, it becomes more difficult to alter taxes retroactively and the Internal Revenue Service has warned that it would delay processing tax returns and mailing refunds.
Sen. Thomas R. Carper, Delaware Democrat and a member of the Senate Finance Committee, said last week that it is “not at all clear” that Congress can get it done in the lame-duck session.
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A deal floated on Capitol Hill last week for a $450 billion package that would restore most of the tax breaks for 10 years, make some permanent and phase out the wind energy credit by 2018 was quickly met with a veto threat from the White House.
The plan had numerous drawbacks, including red ink in future budgets that irked conservatives. But the administration’s knee-jerk rejection of a long-term deal bode badly for compromise in the lame-duck session and for any deal when Mr. Obama faces a Republican-led Congress next month.
The mortgage debt relief exemption gained momentum in the Senate last spring but fell victim to the partisan battle over the chamber’s rules and the amendment process.
The Senate took up a bill known as the Expire Act that would have extended all of the tax breaks, but Senate Majority Leader Harry Reid, Nevada Democrat, refused to allow Republicans to offer amendments that would have nixed the wind energy tax credit and the unpopular medical device tax that helps finance the president’s Affordable Care Act.
Senate Republicans retaliated by killing the bill with a filibuster.
The bill would have a better chance of passing the Senate if it reaches the floor in the lame-duck session. Mr. Reid is expected to loosen his grip on proceedings as he prepares for Republicans to take over majority control of the chamber next year.
The fate of the bill would be uncertain in the House, where Republican leaders have said that they prefer tackling a complete reform of the tax code rather than doing it piecemeal with temporary extenders.