THE FEDERAL tax code's most glaring penalty for unsuspecting homeowners - a double-whammy when they're down and out and can least afford it - appears finally to be on the verge of reform.
Two influential senators have begun pushing a bipartisan bill that would end the tax code's harsh treatment of homeowners who fall seriously behind on their mortgage payments and face imminent foreclosure.
Many homeowners in this situation turn to their lenders to work out some form of accommodation that avoids the crushing costs of foreclosure. Frequently the solution involves what's known as a "short sale," a quick transfer of the property to investors or others at less than the full market value of the house.
Sometimes lenders agree to forgive a portion of the homeowner's mortgage debt, thereby easing the financial burden on people in distress who've just lost their home. But instead of encouraging such benevolence, the federal tax code has a built-in poison pill for homeowners who accept mortgage debt forgiveness: The government treats every cent of forgiven mortgage debt as earned income by the home-owning taxpayer, taxable at regular income tax rates, even though the taxpayer may have just lost everything.
The Mortgage Cancellation Relief Act of 2000, co-sponsored by Democratic Sen. Bob Kerrey, of Nebraska, and Republican Sen. Orrin G. Hatch, of Utah, would remove the poison pill from the code, and free home sellers of their current debt-forgiveness tax burdens.
A nearly identical bill, co-sponsored by Democratic Rep. Robert E. Andrews, of New Jersey, and GOP Rep. Mark Foley, of Florida, already has passed the House. Since both Kerrey and Hatch are members of the tax-writing Senate Finance Committee, the odds that their bill will be included in any major congressional tax legislation this fall appear favorable.
To get a sense of how unfair the current law is, consider this hypothetical example. Say you bought a house for $150,000 with a $135,000 mortgage. Within the year you had some bad luck, got sick, couldn't continue working, and no longer had the monthly income to pay the mortgage. Your lender sent you delinquency notice after delinquency notice, and finally uttered the "F" word: Foreclosure.
