IRS Provides Flexibility to Take Advantage of Income Exclusion for Mortgage Debt Modifications Before December 31

IRS Provides Flexibility to Take Advantage of Income Exclusion for Mortgage Debt Modifications Before December 31

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Certain discharges of qualified principal residence indebtedness are excluded from taxable income under a special provision of the tax code that is set to expire Dec. 31, 2016. The IRS recently provided guidance on conditions that will be deemed to satisfy this timing requirement, even if a loan modification is not finalized with a lender by December 31.

Homeowners with distressed loans may be eligible for loan modifications and a tax break.Homeowners maintaining distressed mortgage loans, such as those obtained during the subprime mortgage crisis, may be eligible for loan modifications under the federal government’s Principal Reduction Modification Program (PRMP) or the Home Affordable Modification Program (HAMP). Mortgage loans can be renegotiated under these programs, potentially allowing homeowners to lower their monthly payment amount, and possibly the mortgage principal amount.

Absent a special provision, loan modifications such as these come with an unwelcome tax consequence: debt forgiveness normally generates taxable income.  Fortunately, for several years homeowners have had relief available. Relief from underwater mortgages has been a nontaxable event under a special provision, but this provision is set to expire on Dec. 31, 2016. Specifically, an arrangement for a discharge of indebtedness must be entered into and evidenced in writing before Jan. 1, 2017, to qualify under the timing of this provision. Loan modifications resulting in discharged debt that do not meet this condition will be taxable beginning in 2017.

In an effort to provide relief for as many taxpayers as possible, the IRS recently provided an additional outlet that taxpayers may use to qualify for this provision before it expires. In Notice 2016-72, the IRS explained that taxpayers will qualify for this provision, even though the loan modification is not finalized with a lender by December 31, as long as the following conditions are met by December 31:

  1. A mortgage-servicer (lender) sends the borrower-homeowner a notice that outlines the terms and conditions of the permanent loan mortgage loan modification;
  2. The borrower-homeowner satisfies all of the trial period and PRMP conditions; and
  3. The borrower-homeowner and mortgage-servicer enter into a permanent modification of the mortgage loan on or after January 1, 2017.

Thus, a borrower-homeowner can enter into an “active trial plan period” with a mortgage-servicer (lender) during 2016, receive the required notice from the lender during 2016 and complete the plan/modification process after Dec. 31, 2016, while remaining eligible for the taxable income exclusion on mortgage debt discharged.

Trial plan periods frequently run for terms such as three months, so with this new guidance, the completion of this monthly plan can take place after December 31. This new guidance provides homeowners with one last opportunity to take advantage of the income exclusion rule. Taxpayers therefore still have time before December 31 to work with lenders in negotiation of a plan that meets the above three criteria that will enable them to benefit from this very favorable tax provision.

If you may be affected by this new benefit, contact your CBIZ MHM tax professional to discuss your options.


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IRS Provides Flexibility to Take Advantage of Income Exclusion for Mortgage Debt Modifications Before December 31Individuals have one last opportunity to take advantage of an income exclusion rule for mortgages....2016-12-12T17:54:00-05:00Individuals have one last opportunity to take advantage of an income exclusion rule for mortgages.