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Summary

During 2007, the rate of foreclosures and mortgage defaults has been rising to new levels. As lenders and borrowers work to resolve indebtedness issues, some transactions are resulting in cancellation of debt. Mortgage debt cancellation can occur when lenders restructure loans, reducing principal balances, or sell properties, either in advance, or as a result, of foreclosure proceedings. If a lender forgives or cancels such debt, current tax law treats it as cancellation of debt (COD) income subject to tax. There are exceptions for taxpayers who are insolvent or in bankruptcy, among others -- these taxpayers may exclude canceled mortgage debt income under existing law. The Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648), which was passed by the House by a vote of 386 to 27 on October 4, 2007, would exclude qualified COD income. Thus, the act would allow taxpayers who do not qualify for the existing exceptions to exclude COD income. Other legislation proposing similar relief has also been introduced (H.R. 1876, H.R. 3506, H.R. 3996, and S. 1394). The President has expressed support for the legislation generally, but has stated a preference for a temporary tax provision -- the bills' provisions are permanent. A rationale for excluding canceled mortgage debt income has focused on minimizing hardship for households in distress. Policymakers have expressed concern that households experiencing hardship and possibly losing their homes, presumably as a result of financial distress, should not incur an additional hardship by being taxed on canceled debt income. Some analysts have also drawn the connection between minimizing hardship for individuals and consumer spending; reductions in consumer spending, if significant, can lead to recession. Additionally, legislators have been pursuing Federal Housing Authority (FHA) and governmentsponsored enterprise (GSE) reform efforts, in part to alleviate the current mortgage crisis. As efforts to minimize the rate of foreclosure are being made, lenders are, in some cases, renegotiating loans with borrowers to keep them in the home. For some policymakers, the exclusion of canceled mortgage debt income may be a necessary step to ensure that homeowner retention efforts are not thwarted by tax policy. Opponents of an exclusion for canceled mortgage debt income might argue that the provision would make debt forgiveness more attractive for homeowners relative to current tax law and could encourage homeowners to be less responsible about fulfilling debt obligations. Congress may or may not choose to enact an exclusion for canceled mortgage debt income. If this choice is made, the question arises as to whether an exclusion should be granted for all homeowners. Alternatively, the exclusion could be limited. Limits could be placed on such things as the amount of income excluded, the type of households eligible to claim the exclusion, and the type of canceled debt eligible to be excluded. Finally, the provision could be temporary rather than permanent. This report will be updated in the event of significant legislative changes.

Related Legislation:
• H.R.3648
• H.R.1876
• H.R.3506
• H.R.3996
• S.1394

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