The Internal Revenue Service has issued Revenue Ruling 2014-02, explaining the tax treatment of payments under the National Mortgage Settlement to homeowners whose principal residences were foreclosed by mortgage servicers using techniques such as “robosigning,” where there was little documentation or examination by qualified bank officials.

Last year, the federal government and the attorneys general of 49 states and the District of Columbia entered into settlement agreements with five bank mortgage servicers to address mortgage loan servicing and foreclosure abuses. One component of the National Mortgage Settlement is the Borrower Payment Fund, which the parties intended to be structured as a qualified settlement fund under Section 1.468B-1 of the income tax regulations.

The terms of the settlement agreements provide that the five mortgage servicers collectively will pay approximately $1.5 billion into the fund, which in turn makes payments to certain borrowers who lost their principal residences in foreclosure on or after Jan. 1, 2008, and on or before Dec. 31, 2011.

One of the main issues covered in the Revenue Ruling issued by the IRS last week is the proper tax characterization of the National Mortgage Settlement payment. In addition, if the NMS payment is characterized as part of the amount realized on the foreclosure, and if that characterization creates or increases a gain on the foreclosure of the principal residence, the Revenue Ruling also addresses whether there are grounds for the taxpayer to exclude from gross income some or all of that gain.

Another issue is, if the property for which a taxpayer receives an NMS payment contained one or more additional dwelling units that were not used as the taxpayer’s principal residence, the IRS explains how the NMS payment should be allocated between the portion of the property that the taxpayer used as a principal residence and the rest of the property.

In addition, if a borrower who was eligible for an NMS payment died before receiving it, the Revenue Ruling describes the tax treatment of the person who receives that payment.

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