Some homeowners could end up paying a lot more in 2014 income taxes if Congress doesn’t renew a law it passed after the housing bubble burst.
The Mortgage Forgiveness Debt Relief Act exempted homeowners from paying taxes on debt forgiven by the bank that would otherwise be considered income by the IRS.
Before this law, if you got rid of your home in a short sale or were foreclosed upon, whatever money you owed your bank that it forgave would be taxed by the federal government.
But the bill expired at the end of last year, and Congress hasn’t appeared to be in a rush to renew it before leaving for winter recess in about a month.
“I know how slow government works. I’ve lived it for the past two years. I know exactly how slow it works,” said Jennifer Herrick, whose Sayreville, New Jersey, home flooded during Superstorm Sandy.
“So, knowing that they have to pass this and get [President Barack Obama’s] signature on it before winter recess is terrifying.”
Herrick’s home flooded three times in less than three years, so her family decided to take a buyout through the state’s Blue Acres program. But due to its history of taking in water, the home fetched about $70,000 less than what the Herricks still owed on their mortgage, which the bank wrote off.
“We will owe the IRS approximately $22,000 of income tax on money that we never actually earned,” said Herrick. She added that the forgiven debt is “more money than I make in a year as a teacher.”
The lapse in the law has national implications for homeowners, but it could seriously hurt states including New Jersey, where foreclosure rates are high and many homeowners are “underwater” on their mortgages.
“I think that we’ll continue to see what we have this year in 2014, and that’s a tremendous spike in personal bankruptcies,” said Benjamin Dash, a lawyer at Dash Farrow in Moorestown, New Jersey.
Homeowners with average incomes who have had large debts written off are especially at risk, Dash said.
“I’ve had clients who earned $40,000 or $50,000 a year where the bank writes off $200,000,” said Dash, “and they move up not one tax bracket but potentially two tax brackets.”
U.S. Sen. Robert Menendez, D-New Jersey, a member of the Finance Committee, said he believes Congress will extend the bill by the end of the year. “The last thing we should be doing is imposing this additional tax burden on these families who simply cannot afford it,” he said in a statement.