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PROPOSAL FOR MORTGAGE FORGIVENESS WOULD HIT VACATION HOME OWNERS

September 26, 2007

The House Ways and Means Committee is working on a bill to exempt home mortgage debt forgiveness from taxes. The bill would only qualify for the debt incurred on purchasing and improving the home; equity loans would not qualify.

The bill would make up some of the lost tax revenue by restricting the gain exclusion on the sales of vacation homes that are converted to primary residences. The bill would reduce the $250,000 exclusion on the gain on the sale of a principal residence ($500,000 on joint returns) for periods the home was not used as a principal residence. An example from the Joint Committee Explanation of the bill:

Assume that an individual buys a property on January 1, 2008, for $400,000, and uses it as rental property for two years claiming $20,000 of depreciation deductions. On January 1, 2010, the taxpayer converts the property to his principal residence. On January 1, 2012, the taxpayer moves out, and the taxpayer sells the property for $700,000 on January 1, 2013. As under present law, $20,000 gain attributable to the depreciation deductions is included in income. Of the remaining $300,000 gain, 40% of the gain (2 years divided by 5 years), or $120,000, is allocated to nonqualified use and is not eligible for the exclusion. Since the remaining gain of $180,000 is less than the maximum gain of $250,000 that may be excluded, gain of $180,000 is excluded from gross income.

The cutback on the exclusion would only be for "nonqualified" use after 2007, so you still have three months or so to move into your vacation home, live there for two years, and qualify for the full exclusion. Assuming, of course, the bill will pass.

Of course, there is already a tax law that allows insolvent or bankrupt taxpayers to avoid taxes on debt forgiveness. This bill makes people who spend too much on houses a protected class of taxpayers. Those poor saps who ran up crushing debt paying for college or gambling (in casinos, not on the housing bubble) are just out of luck.

The Tax Prof has more.

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