Expiring Tax Cut Poised To Take a Bite Out of Mortgage Settlement Payouts (Opinion)

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By Adam Levin

It just may become the latest outrage during a year of outrages. At the precise moment when the federal government finally delivers a modicum of justice and some economic relief to millions of homeowners victimized by the nation's largest banks, the government threatens to beat those victims over the head with a punitive old favorite revenue-raiser -- a tax on forgiven debt.

Here's the backstory: After years of standing on the sidelines and ignoring evidence that major banks were using their mortgage servicing arms to steal money from innocent consumers and illegally evict homeowners, the federal government finally joined with 49 states to prosecute the banks. It was a frustrating, agonizingly slow and painful process that led to an even more frustrating, agonizingly slow and painful negotiation.

The result was the National Mortgage Settlement, in which the five largest loan servicers must pay $21.5 billion in reparations and restitution to consumers victimized by their inappropriate conduct. Specifically, many homeowners whose mortgages were serviced by the Big Five -- Citi, JPMorgan Chase, Wells Fargo, Bank of America and Ally Financial -- may qualify for significant reductions in their mortgage principal and interest rates. And 1.5 million people who lost their homes due to questionable foreclosure practices can apply for a one-time payment of $2,000 (an insultingly low figure considering how much pain is involved in losing one's house).

Altogether, that's not an inconsequential number even in an imperfect world. More importantly, it's desperately needed right now by millions of underwater homeowners, who just might be able to hang onto their homes if they can receive the lower payments that come from interest and principal reductions. That helps individual homeowners, and it also helps everyone else, since our economy needs more foreclosures and more empty houses like it needs another global stock market crash.

But a gridlocked, polarized Congress is about to screw it up (again). You see, unless Congress acts with uncharacteristic speed and bipartisanship, anyone who might receive a principal reduction from the mortgage settlement could face a hefty tax bill.

That's not supposed to be the way this all goes down. In 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act, which prevents homeowners from paying taxes when their mortgage debt is forgiven due to a decline in the owner's financial life or a drop in the home's value. (We first covered the debt cancellation tax, known as the 1099-C, early last year, and gave tips on what to do if the IRS taxes you on cancelled debt.)

The law applies to homeowners who participate in the National Mortgage Settlement who receive up to $2 million in reduced principal and interest charges. It is scheduled to expire at the end of 2012 along with all the other tax cuts we have heard about for years.

Whoops.

So, instead of getting the relief they need to save their houses, victimized homeowners will be forced to pay a significant portion of that savings to Uncle Sam. Since the average homeowner will receive about $19,000 in settlement relief, and the average middle class family pays about 25 percent in taxes, approximately one quarter of the forgiven debt -- some $4,750 -- will have to be paid to the IRS and by those who can least afford to pay it. For some families, that could be enough to tip the scales, pushing them back to the brink of foreclosure and eviction.

This is fiscal insanity. And Congress knows it.

"Suddenly, just when they throw you a life ring, they jerk it back," Rep. Jim McDermott (D-Wash.), told the Los Angeles Times. "We cannot let this happen. It's going to be a disaster."

To his credit, McDermott has introduced a bill that would extend the tax cuts until 2015. But herein lies the first indication of Congressional business as usual on this issue. A different bill, introduced by Sen. Debbie Stabenow (D-Mich.), also would extend the tax cuts, and has a better chance of passing than McDermott's, since it has bipartisan support from 17 co-sponsors of both parties.

So what's the problem? McDermott's bill extends the tax cuts until 2015, the same year in which the major banks must complete distributing restitution to their victims. Stabenow's more popular bill, on the other hand, extends the tax cuts only until 2014; meaning that even if it passes, some homeowners will be pushed to the precipice of the exact same financial cliff two years hence.

Dumb? Yep. And but that's only the Democrats' portion of the stupidity. Republican stupidity is found in the party's complete legislative blockade, a strategy they have pursued over the last two years to deny President Obama even a sliver of economic success. The odds that the members of the Party of No will find it in their hearts (or their steely-eyed political calculations) to save homeowners from this counter-productive tax in the next two months are only slightly better than the odds of America achieving universal peace by Election Day.

And what happens after the election? That's anybody's guess. I rather doubt, however, that forcing Wall Street megabanks to pay billions of dollars in restitution to regular homeowners will be Priority #1 in the event of a Romney-Ryan administration. Those aren't the taxes they are looking to cut (wrong bracket).

No matter who wins on Nov. 6, however, this tax is wrong, and it must be allowed to lay dormant where it belongs. Innocent homeowners who were victimized by robosigning, illegal evictions, and loan servicing shenanigans aren't getting rich here. It's about keeping people in their homes and preserving neighborhoods. Actually, it is a real stimulus package.

Democrats must get serious and back legislation that protects all the relief won in the National Mortgage Settlement, not just some of it. Republicans must stop their willful obstructionism, and follow through on their oft-repeated promises to prevent taxes that hurt the economy.

If Congress can come together to save homeowners' lifelines, then it deserves some credit for finally doing its job. But if Congress fails to fix this looming problem, it will become the biggest single outrage of an already outrageous legislative season. As we prepare to vote this November 6, let's demand action before the election and foreclose upon those congressmen and senators who fail to act before it's too late.

See more on Credit.com:
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How to Avoid a Debt Spiral
Why Are Short Sales So Bad for Your Credit?

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Expiring Tax Cut Poised To Take a Bite Out of Mortgage Settlement Payouts (Opinion)
Your home is where the refund is. Whether they are home office deductions, tax credits for new purchases, renovations, or "green" tax incentives, Uncle Sam is able to help you recoup some of your expenses you've put into your home.
That is, provided you have all the receipts, manufacturer's certificates and other required paperwork for any deduction or credit you plan to claim on your tax return.
Homeowners have lots to wade through to determine what all they might juggle when it comes to tax planning. To make tax preparation easier, we have outlined the following tips to help homeowners navigate tax season this year.
You can deduct lawn maintenance if you fit the "business use" test, says Bay Area tax expert Gary Price, of accounting firm Sensiba San Flippo (ssfllp.com).
Lawn care and landscaping expenses are deductible if the taxpayer's client's regularly visit the home office, or where the lawn is used as part of the business, as in a daycare provider with children going out on the lawn for play area. Yes, this even applies to snow removal. Use form 8829.
If you primarily work from home, you should be able to deduct a percentage of your mortgage interest, real estate taxes, casualty losses, home repairs and maintenance, utilities, house insurance, security system and even garbage removal based on the square footage of your home office space compared to the overall square footage of your home.
"In order to qualify as a home office in the eyes of the IRS," says tax attorney Roni Deutch, CEO of the Roni Deutch Tax Center, "you need to have a separate room or designated space that is used exclusively for business purposes. If it is not a room, then the space needs to be separated by a room divider of some sort. Additionally, the IRS is very strict about the exclusive use rule, so if your children play in the office or your spouse uses the room as a home gym then it will not qualify."
Use IRS Form 8829 if you are self-employed. Download Publication 587 for IRS rules. And if turned an old bedroom into an office space using California Closets or other remodeling project, you should be able to deduct that expense too for work, if you itemize.
Did an adult child, other relative or friend move in with you after a job or home loss or for another reason? If so, and you've been charging them rent, you can deduct a portion of their living space, says CPA Brenda Schafer, CFP, from the Tax Institute at H&R Block in Kansas City, MO.
"Depreciation is allowed only for areas used exclusively by the renter, such as a bedroom and separate bathroom. If total allowed deductions exceed the rental income, a loss is generally allowed up to certain limitations."
If you converted a basement, attic, garage or other space into rental quarters, Uncle Sam gives you a break on the remodeling costs.
"Converting a basement to a separate rental unit is treated as a "regular" rental. Mostly, that means that depreciation on the rental portion of the home is allowed. Expenses to remodel the basement would be added to the depreciable basis of the basement of the house and would be depreciated," Schafer told HousingWatch.
Windows, storm windows, certain fuel stoves, doors, and storm doors, all qualify, says John Egan. "The neat thing about the credit is that you could replace just a few windows in your home or even put a window in an area of your home where there is not one." Perhaps put a skylight in the kitchen.
"A very simple skylight can give a whole new look to a kitchen or family room and get a big discount," he says. File form 5695 with your tax return.
Even replacing your window shades or adding a window film to the glass can get you a tax credit. Duette Architella shades by Hunter Douglas (previous picture) qualify for the tax credit, as does Panorama solar control window film (pictured).
Homeowners can receive a 30 percent credit on the cost of qualifying window coverings, up to $1,500. Installation costs do not apply. This tax credit applies only to improvements made to a primary residence from Jan. 1, 2009 through Dec. 31, 2010. Complete IRS form 5695.
Qualified biomass stoves and furnaces heat a home or water by burning biomass fuel, such as corn, cherry pits, wood pellets, plants and fibers. The tax credit covers the product and in some cases the installation, which is a good thing because the larger products are not cheap.
The inexpensive models can cost $700, but the larger units go for $4,000 or more. The Harman PC45 Corn/Pellet Stove (pictured) runs about $3,500, a spokesperson for the company told AOL Real Estate. Installation fees can add another $500. Some biomass fireplace inserts, which are heating units that retrofit into an existing fireplaces, might qualify for the tax credit.
Energy-saving home upgrades also qualify for tax deductions, says John Egan, a certified financial planner with JM Egan Wealth Advisors in Madison, NJ. "The government-sponsored energy credit is the easiest one to qualify for and the most practical one to get tremendous savings on needed home improvements," he told AOL Real Estate.
"It can only be used in your primary residence and offers 30% as a tax credit up to $1,500,. That's a dollar-for-dollar credit as long as you have some income tax of at least $1,500. That means you can get a 30% savings on a $5,000 home improvement." From lightbulbs to spray-on insulation like Icynene that helps cut down on air leakage, there are many products and upgrades that qualify, helping you increase energy efficiency. Some other products have no max on the credit and for some you can even carry forward the tax credit over several years until 2016.
Adding on a new reflective roof could qualify you for a tax deduction if you choose the right product, reports the Metal Roofing Alliance. Asphalt roofs with appropriate cooling granules meet the requirements, as do metal roofs with certain pigmented coatings.
Metal roofs can resemble slate, shake and tile, such as the one pictured of an Allmet Roofing Products. If your house is shaded and the roof is not exposed to much sun, or your attic is well insulated, this might not be the product for you.
Thanks to the Residential Energy Efficient Property Credit, seriously "green" homeowners that have installed alternative energy equipment, such as solar hot water heaters and geothermal heat pumps and wind turbines, can be eligible for a credit up to 30 percent of the cost of equipment and the installation, with no cap, except on fuel cells.
Buyers of small wind turbines, including vertical axis ones made by Helix Wind (pictured), can claim a credit through 2012 provided installation began in 2009 or 2010.
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