The Internal Revenue Service is offering guidance on mortgage principal reductions in the federal government’s program for mortgage modifications for borrowers who have fallen behind on their payments.
The guidance in
To help financially distressed homeowners lower their monthly mortgage payments, the Treasury Department and HUD established HAMP, which is described at
Under the program, if the loan is in good standing on the first, second and third annual anniversaries of the effective date of the trial period, the loan servicer reduces the unpaid principal balance of the loan by one-third of the initial PRA Forbearance Amount on each anniversary date.
This means that if the borrower continues to make timely payments on the loan for three years, the entire PRA Forbearance Amount is forgiven. To encourage mortgage loan holders to participate in HAMP–PRA, the HAMP program administrator will make an incentive payment to the loan holder, known as a PRA investor incentive payment, for each of the three years in which the loan principal balance is reduced.
The guidance issued Thursday by the IRS provides that PRA investor incentive payments made by the HAMP program administrator to mortgage loan holders are treated as payments on the mortgage loans by the United States government on behalf of the borrowers. These payments are generally not taxable to the borrowers under the general welfare doctrine.
If the principal amount of a mortgage loan is reduced by an amount that exceeds the total amount of the PRA investor incentive payments made to the mortgage loan holder, the borrower may be required to include the excess amount in gross income as income from the discharge of indebtedness. However, many borrowers will qualify for an exclusion from gross income.
For example, a borrower may be eligible to exclude the discharge of indebtedness income from gross income if (1) the discharge of indebtedness occurs (in other words, the loan is modified) before Jan. 1, 2014, and the mortgage loan is qualified principal residence indebtedness, or (2) the discharge of indebtedness occurs when the borrower is insolvent. For additional exclusions that may apply, see
Borrowers receiving aid under the HAMP–PRA program may report any discharge of indebtedness income—whether it is included in, or excluded from, gross income—either in the year of the permanent modification of the mortgage loan or ratably over the three years in which the mortgage loan principal is reduced on the servicer’s books. Borrowers who exclude the discharge of indebtedness income must report both the amount of the income and any resulting reduction in basis or tax attributes on
The guidance issued Thursday explains that mortgage loan holders are required to file a
Penalty relief is provided for mortgage loan holders that fail to file and furnish the required Forms 1099-C on a timely basis, as long as certain requirements described in the guidance are satisfied.
