|Thomas Wechter||Colleen Feeney Romero|
The Mortgage Relief Act of 2007 and the Rescue Act of 2008
Too little, too late.
In an attempt to ameliorate the effects of the subprime mortgage loan crisis on the American homeowner, Congress enacted and the President signed into effect two key pieces of legislation. First, in December 2007, the Mortgage Forgiveness Debt Relief Act of 2007 (Mortgage Relief Act) was enacted. While the Mortgage Relief Act includes a host of provisions not connected to mortgage forgiveness relief, it excludes from gross income, the discharge of “qualified principal residence indebtedness.” In July 2008, the American Housing Rescue and Foreclosure Prevention Act of 2008 (Rescue Act) was enacted. The Rescue Act also carries a number of tax changes, including, but not limited to, tax breaks for first-time homebuyers.
The Mortgage Relief Act of 2007
Specifically, under the Mortgage Relief Act, the discharge of “qualified principal residence indebtedness” is excluded from gross income. Code §108(a)(1)(E). Qualified principal residence indebtedness is acquisition indebtedness under Code §163(h)(3)(B) with respect to the taxpayer’s principal residence. Taxpayers may exclude debt forgiven on their principal residence, if the balance on the loan was less than $2 million or $1 million for married individuals filing separate returns. The debt must have been used to buy, build or substantially improve the taxpayer’s principal residence and debt must also be secured by the residence. Debt reduced through mortgage restructuring may also qualify for relief. But relief generally does not extend to any increase in the original mortgage balance as a result of refinancing. However, the exclusion does not apply to the discharge of a loan if the discharge is due to any other factor not directly related to a decline in the value of the residency or the taxpayer’s financial condition. If a taxpayer elects to exclude the cancelled mortgage income under the qualified principal residence exclusion, the basis of the taxpayer’s principal residence is reduced by the excluded amount, but not below zero.
Alternatively, an insolvent taxpayer may elect to rely on the Code §108(a)(1)(B) exclusion for insolvent taxpayers instead of applying the mortgage forgiveness exclusion apply. Code §108(a)(2).
When and How to Claim the Debt Relief
The discharge must occur on or after January 1, 2007 and before January 1, 2010. However, if the Emergency Economic Stabilization Act of 2008 is enacted, the Mortgage Relief Act of 2007 would extend relief from cancellation of indebtedness income through 2012.
The debt relief can be claimed on Form 982, which was released earlier this year. IRS cautions borrowers to pay particular attention to the amount of debt forgiven and the fair market value reported on the Form 1099-C received from the lender. News Release 2008-17 (December 2, 2008). If the taxpayer does not agree with the lender’s assessment of fair market value, it would be recommended that an evaluation by an independent appraiser be made.
The Rescue Act of 2008The Rescue Act provides first-time homebuyers a refundable tax credit for qualifying purchases of principal residences after April 8, 2008 and before July 1, 2009. Eligible homebuyers may claim a refundable tax credit equal to the lesser of 10 percent of the purchase price of a principal residence or $7,500 ($3,750 for married individuals filing separately). See Code §36.
Phase-Out of Credit
The credit phases out for individuals with modified adjusted gross income (MAGI) between $75,000 and $95,000 during the year of the purchase. MAGI is adjusted gross income for the tax year increased by certain amounts excluded from gross income, (e.g. foreign earned income and foreign housing exclusions, income derived from American Samoa) or income from Puerto Rico. Code §36(b)(2).
First-Time Homebuyer and Qualifying Home
A taxpayer is considered a first-time homebuyer if he had no present ownership interest in a principal residence in the United States during the three-year period prior to the purchase of the home to which the credit applies. Code §36(c)(1). Thus, a prior owner of real estate may qualify if the three-year test is met. IR-2008-106.
A home purchase qualifies only if: (1) the property is not acquired from a person related to the buyer and (2) the basis of the property in the hands of the buyer is not determined by reference to the adjusted basis of the property in the hands of the person from whom it was acquired or under Code §1014(a) (property acquired from a decedent). Code §36(c)(3).
A home under construction is considered “purchased” by a taxpayer on the date he first occupies it. Code §36(c)(3)(B). Thus, it would be wise for taxpayers to fix the completion date of a home under construction to allow time to occupy it prior to July 1, 2009.
When and How to Claim the Credit
Eligible homebuyers may claim the credit in 2008 for qualifying purchases in 2009. Thus, in certain cases, one may be able to get a refund of the credit shortly after the purchase closes. Code §36(g).
The credit can be claimed on the new Form 5404, which will be released shortly.
The credit for new homebuyers is recaptured ratably over 15 years, with no interest charge, beginning with the second tax year after the year the credit is claimed. As IR-2008-106 stresses, the credit for new homebuyers is the same as a long-term interest-free loan from the government.
There are a number of exceptions to the regular recapture rule that result in accelerated recapture. If the taxpayer who claimed the credit on an individual return dies, the remaining credit is not recaptured. However, if the taxpayer claimed the credit on a joint return, the regular and accelerated recapture rules would apply to the surviving spouse for one-half of the remaining repayment amount.
The same rule applies to the transfer of the residence to a former spouse incident to divorce. If the taxpayer who had claimed the credit, sells the home or no longer uses the home as a principal residence before complete repayment of the credit amount, any remaining portion of the credit amount is due when the tax return for the year in which the home is sold (or ceases to be the principal residence). If the home is sold, the amount of the credit repayment amount cannot exceed the gain, if any, computed by reducing the home’s basis by the amount of the credit amount due.Finally, the accelerated recapture amount rules do not apply if the home is involuntarily converted and a replacement residence is purchased within a two-year period of the date of conversion. In that event, the regular recapture rules apply to the replacement home.
ConclusionWhen you stand back, it appears that the provisions granting relief from cancellation of debt-income for principal residences and the first-time homebuyer’s credit foster the very evils that lead to the subprime crisis. Neither provision makes the homeowner accountable or responsible. The relief from cancellation of debt income provides an incentive for a taxpayer to over-leverage the purchase of a home and then to walk away from his/her indebtedness if s/he cannot make the mortgage payments. In addition, the first-time homebuyer credit allows taxpayers to over-leverage the purchase of a home without any accountability as to whether the taxpayer will be able to pay the mortgage.
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