bomb About a month ago, I wrote in Salon about a potential time-bomb embedded in the efforts to increase debt relief for mortgages, the expiration of the Mortgage Forgiveness Debt Relief Act. Finally, some mainstream sources have gotten around to reporting on this, in basically the same way and with even many of the same principals quoted. Jim Puzzanghera writes at the LA Times:

A special exemption of as much as $2 million per household in principal reduction and other aid from banks, in place since 2007, is set to expire at year’s end.

Housing advocates and lawmakers are worried that the exemption will disappear just as thousands of homeowners are receiving large amounts of mortgage debt relief from the nation’s five largest banks as part of a national settlement of foreclosure abuse investigations.

“The expiration of that provision is a hidden time bomb,” said Rep. Jim McDermott (D-Wash.).

He and other lawmakers are expected to push for an extension of the special tax exemption when Congress returns from summer recess next week, but even with bipartisan support it’s unlikely to get a vote before the November election.

The report mentions at the end, as I have reported, that a one-year extension of the debt forgiveness tax relief has passed inside a tax extenders package out of the Senate Finance Committee. That appears to be the only vehicle available at this time, outside of some omnibus package at the end of the year around avoiding the fiscal cliff. But just today, Speaker John Boehner said he wasn’t confident about Congress doing anything on the fiscal cliff after the election. That leaves the tax extender deal, and with the major pre-election business of Congress wrapping up as early as this week, and only two weeks in the whole session, I find a tax extender passage highly unlikely.

Puzzanghera does relate how the recent foreclosure fraud settlement makes this principal reduction tax issue all the more freighted. The first report of the settlement monitor showed that banks delivered $10.6 billion in debt relief from March 10-June 30. As we know, about 80% of that came from short sales. But short sales count as a principal reduction for tax purposes, and so most of that $10.6 billion, in a world where the Mortgage Forgiveness Debt Relief Act expired, would face a tax of anywhere between 25% and 30% (especially if the amount of the principal reduction pushes them into a higher tax bracket, or if the Bush tax cuts expire). This shows that the CBO estimate of $1.3 billion in costs for a one-year extension is wrong; on short sales alone, families would owe $2 billion for just the March 1-June 30 period.

This, by the way, is why banks and homeowners are speeding through short sales, trying to get them in before the tax relief expires.

Kelley said more homeowners are pushing to short-sell their homes by the end of the year, when the Mortgage Forgiveness Debt Relief Act is set to expire unless Congress acts to extend it. If Congress does not extend this law by Dec. 31, she said any amount of money a bank writes off in agreeing to sell a home as part of a short sale will become taxable income when sellers pay their income taxes.

Obviously, this distorts the market, creating a lot of distressed sales that investors are buying up in record numbers.

I’m glad there’s a modicum of more attention being paid to this issue. It would be absolutely brutal for families getting a credit for acts of abuse perpetrated upon them to then have to pay up phantom money from the credit to the government.

Graphic by HTML’s Magic under Creative Common’s License