Foreclosure and Taxes

from www.nytimes.com

Published: August 24, 2007
To forgive is divine, except when the thing being forgiven is debt. Then, it’s taxable.
The taxability of forgiven debt is set to become a pressing issue as more homeowners fall behind on their mortgages and face foreclosure. As Geraldine Fabrikant reported in The Times this week, some foreclosed homeowners face a double whammy. First they lose their homes; then they get billed for taxes on the amount of debt that was presumably wiped away in the foreclosure.
In principle, there is nothing wrong with taxing defaulted debtors on the part of their mortgage that goes uncollected. The law rightly provides that when a borrower fails to repay, the unpaid balance becomes taxable income. Nor is the problem with the Internal Revenue Service. When the I.R.S. sends tax bills to foreclosed borrowers, it is using information provided by lenders.
Nevertheless, problems are rife. One of the biggest occurs when lenders misreport forgiven-debt data to the I.R.S. In general, a lender must report the difference between the mortgage balance and the house’s fair market value at the time of foreclosure. But some lenders fail to keep track of recent home appraisals or the ultimate sales prices of foreclosed properties. Instead, they may compute the forgiven debt using an interim distress price that’s slapped on a foreclosed house before it’s resold, say $1. The result is a huge — and hugely erroneous — tax liability.
For foreclosed borrowers hit with unexpected tax bills, figuring out if they have been wrongly charged can be an insurmountable burden. They generally need to pay for expert tax advice and may struggle to extract the necessary information from faceless lenders. They’re also subject to the unavoidable stress that comes with having a problem with the I.R.S. If a borrower isn’t up to the challenges, the result could be payment of taxes that aren’t owed, or nonpayment of taxes that have been assessed — either of which could be ruinous for people who are trying to rebound from foreclosure.
Congress needs to pay attention. Lawmakers held hearings this year that exposed the reckless and predatory lending behind many of today’s foreclosures, but they have yet to provide any substantial assistance to imperiled homeowners. This lack of urgency stands in stark contrast to the swift government response to mortgage-related woes on Wall Street.
A typical excuse for delay is that legislators must proceed carefully to avoid unintended consequences. But the help that is most needed now is for overwhelmed state, local and nonprofit agencies that counsel beleaguered homeowners on how to renegotiate loans and how to get free or low-cost advice on tax and legal issues. There is no reason for Congress to delay on this.