Struggling Homeowners Confront a ‘Mortgage Fiscal Cliff’

While Congress wrangles over a debt deal, struggling homeowners may be facing a cliff of their own. That’s because a tax break aimed at helping distressed borrowers—set to expire at the end of the year—is caught up in the taxes vs. spending debate paralyzing Washington.

In the early days of the housing crisis, Congress passed the Mortgage Debt Relief Act of 2007, which waives taxes on up to $2 million in loan forgiveness. Normally, forgiven debt is taxed as income. The bill shields borrowers from taxes in three situations: when a bank modifies a mortgage to reduce the principal; when a borrower sells her home in a short sale and the purchase price is less than the outstanding balance on the mortgage; and when a bank waives the portion of the mortgage balance it couldn’t recoup in a foreclosure.

The bill was extended in 2008 and now expires on Dec. 31. In a note to clients earlier this month, Deutsche Bank’s Steven Abrahams called the expiration a “mortgage fiscal cliff” that could drag down the economy and cause more struggling homeowners to file for bankruptcy rather than work out an agreement with their lender.

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