IRS Outlines Tax Consequences for Financially Distressed Homeowners
The Internal Revenue Service has provided guidance on the federal tax consequences of payments made to homeowners under programs established for the hardest hit housing markets, along with the necessary information reporting requirements.
Notice 2011-14 offers guidance on the tax consequences of payments made to or on behalf of financially distressed homeowners under programs established pursuant to the Treasury Department’s Housing Finance Agency Innovative Fund for the Hardest-Hit Housing Markets and the Department of Housing and Urban Development’s Emergency Homeowners’ Loan Program.
In February 2010, the Treasury Department established the HFA Hardest Hit Fund, which is authorized by the Emergency Economic Stabilization Act. The HFA Hardest Hit Fund is designed to allow each state housing finance agency the maximum flexibility in designing locally focused programs to address the needs of financially distressed homeowners within the state or a specific region of the state. Each state program that receives funding from the HFA Hardest Hit Fund has as its primary objective preventing avoidable foreclosures of homeowners’ homes and stabilizing housing markets.
The HFA Hardest Hit Fund is available in states where either housing prices have declined more than 20 percent from peak prices or the unemployment rate equals or exceeds the national average. The states eligible for this funding are Alabama, Arizona, California, the District of Columbia, Florida, Georgia, Illinois, Indiana, Kentucky, Michigan, Mississippi, Nevada, New Jersey, North Carolina, Ohio, Oregon, Rhode Island, South Carolina and Tennessee.
To receive funding from the HFA Hardest Hit Fund, each of these states submitted proposals describing its programs and verifying that each of the programs would meet the requirements of the EESA and the purposes of the HFA Hardest Hit Fund. Funding under the HFA Hardest Hit Fund is available for, but not limited to, programs involving the following transactions: mortgage modifications, principal forbearance to facilitate additional mortgage modifications, short sales and deeds-in-lieu of foreclosure, unemployment programs, principal reductions for homeowners with severe negative equity, and second-lien reductions and modifications.
If assistance to a homeowner under a state program is structured as a forgivable loan, the IRS said it would treat the disbursements to or on behalf of the homeowner as payments to the homeowner rather than as disbursements of loan proceeds, and those payments are treated as occurring at the time the disbursements are made. Similarly, if assistance to a homeowner under the Emergency Homeowners’ Loan Program or a Substantially Similar State Program is pursuant to a HUD Note, the IRS will treat the disbursements to or on behalf of the homeowner as payments to the homeowner rather than as disbursements of loan proceeds, and those payments are treated as occurring at the time the disbursements are made.
Notice 2011-14 offers further guidance on different scenarios and sections of the Tax Code, state by state information, along with the information reporting requirements. It also provdes a safe harbor method under which a homeowner may deduct on his or her federal income tax return an amount equal to the sum of all payments the homeowner actually makes during that year to the mortgage servicer,