Bank of America has pledged $7 billion in mortgage relief for distressed homeowners as part of a massive settlement with the government, but U.S. Attorney General Eric Holder Jr. is warning that borrowers who accept the aid may face a big tax bill.
One form of relief involves lowering mortgage balances for some borrowers who owe more than their homes are worth. However, "underwater" homeowners might have to pay taxes on the forgiven debt, which is considered income by the IRS. Congress took steps in 2007 to avoid this ramification, but the tax break expired last year. While BofA must notify all consumers about this potential tax liability and open a tax relief fund to defray these costs -- up to $25,000 per borrower -- Associate Attorney General Tony West says the fund is not big enough to cover every consumer who may need it and will still leave those who do utilize it on the hook for a big chunk of the tax liability.
Holder says that, absent congressional action, "the hundreds of thousands of consumers we have sought to help through our settlements with JPMorgan Chase, Citigroup, and now Bank of America, may see a significant tax bill just as they are beginning to see the light at the end of a dark financial tunnel." Despite the popularity of the now-defunct Mortgage Forgiveness Debt Relief Act, it is unclear whether Congress will renew it for a third time. An Urban Institute analysis estimates that about 2 million homeowners will be at risk of incurring that kind of tax liability from principal reductions, and a congressional study calculates that borrowers will owe $5.4 billion in extra taxes if Congress fails to renew the tax break.