Lawmakers' Inaction Could Put Homeowners in Double Jeopardy

Early next year, thousands of American homeowners may get an unpleasant surprise in the mail: a tax statement from their mortgage lender announcing that they may owe tens of thousands of dollars in federal income taxes.

Unless Congress acts before the end of 2015, homeowners who had their mortgage principal reduced in a loan modification or lost their homes through a foreclosure or short sale will find themselves in this position.

Under the federal tax code, when a lender forgives part or all of a mortgage, the borrower must count that forgiveness as taxable income. Congress recognized that this tax rule would discourage debt forgiveness as a tool to reduce foreclosures and approved the Mortgage Debt Forgiveness Relief Act in 2007. It has since been extended twice and expired again at the end of 2014. Unless the act is renewed again, mortgage debt that has been forgiven will once again be deemed as taxable income. Homeowners will have to pay tax on that income, whether or not they saw a dime of it.

It's particularly ironic that this is happening even as Ocwen Financial has been aggressively modifying the mortgages of struggling homeowners — essentially complying with the mandate of their own 2013 settlement with the Consumer Financial Protection Bureau, state attorneys general and other regulatory agencies. Under this settlement, Ocwen committed to principal reduction modifications of $2 billion over a three-year period. While Ocwen and other servicers should be commended for their efforts, that work may be for naught if homeowners have to pay for this debt relief in the form of large, unexpected tax bill.

It can be argued that Congress still has plenty of time between now and the end of this year to pass another extension. Indeed, it has done so before, often in late December. But until then, homeowners in this predicament will have a potentially large tax obligation hanging over their heads.