New law awards tax breaks to homeowners

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Homeowners found three attractive tax breaks among their holiday presents, thanks to the federal Mortgage Forgiveness Debt Relief Act of 2007, which was enacted in December. The first tax break concerns forgiveness of debt, which occurs when a lender forgoes repayment of principal and/or interest the borrower owes. Typically, discharged debt is considered ordinary income to the borrower for income tax purposes. The new law allows taxpayers to exclude this amount and thus escape the tax liability. "When you're worried about making your payments, higher taxes are the last thing you need to worry about. So this bill will create a three-year window for homeowners to refinance their mortgage and pay no taxes on any debt forgiveness that they receive," President Bush said in his remarks upon signing the law. Lenders are required to report forgiveness of debt to the Internal Revenue Service, which means taxpayers likely will need to note the amount and the reason for the exclusion on their tax returns. Consult a qualified tax professional for more information and advice about your situation.Under the rules for debt forgiveness:The debt must have been discharged by the lender in 2007, 2008 or 2009.The amount of debt that can be excluded is limited to $2 million. The exclusion can be used only if the loan was taken out to acquire, build or substantially improve a principal residence. Forgiveness of debt on vacation homes, second homes and investment property doesn't qualify. Debt forgiven on a cash-out refinance or home equity loan must be apportioned between the amounts used for home acquisition, construction or improvement and amounts used for other purposes such as tuition, travel or repayment of other debts. Only the allowable portion qualifies for the tax break, says John W. Roth, a senior tax analyst at CCH, a provider of tax services, software and information in Riverwoods, Ill.It's difficult to figure out how many people might qualify, because existing exemptions already shielded many homeowners from this tax liability, according to Sterling Watkins, mortgage broker and owner of Short Sale Services in Folsom, Calif. The second tax break concerns mortgage insurance, which is paid for by the borrower, but protects the lender if the borrower defaults on the loan. The new law extends a one-year deduction of mortgage insurance premiums that was effective in 2007 for three more years, 2008, 2009 and 2010. That time frame means the deduction is allowable only for mortgage insurance on loans that were originated after Dec. 31, 2006, and before Jan. 1, 2011, unless the tax break is further extended in the future. The full deduction is available only to taxpayers whose adjusted gross income is less than $100,000. A partial deduction is allowed for adjusted gross incomes up to $109,000. The deduction is worth $350 for the average taxpayer, according to Mortgage Insurance Companies of America, an industry association. The third tax break concerns capital gains tax on the sale of a principal residence when a person's spouse dies. Federal law allows singles and married couples to exclude $250,000 and $500,000, respectively, of the gain on the sale of their home from capital gains tax if certain tests are met. The differential treatment on the basis of marital status meant that a person whose spouse died had to sell his or her home in the same tax year as the spouse's death to take advantage of the larger tax break. "If your spouse died in December, unless you could sell by Dec. 31, you could only exclude $250,000, instead of $500,000, so you could end up with a horrendous tax bill on the sale of the home, whereas if your spouse died in January, you didn't have that problem," Roth says. The new law allows a surviving spouse to claim the $500,000 if the home is sold within two years after the date of the spouse's death, which eliminates the tax liability on an additional $250,000 of capital gain if the other tests are met as well. Opinions vary as to whether these tax breaks benefit society and the overall U.S. economy, in addition to individual taxpayers. Bush says the debt relief act was "a really good piece of legislation" that would "increase the incentive for borrowers and lenders to work together to refinance loans." But the Tax Foundation, a nonprofit, nonpartisan research group in Washington, D.C., says housing shouldn't be the beneficiary of any more tax breaks. Still, strapped borrowers will probably welcome any legislation aimed at helping those who are upside down on their homes.X...X...XThe benchmark 30-year fixed-rate mortgage plunged 26 basis points, to 5.88 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.35 discount and origination points. One year ago, the mortgage index was 6.24 percent; four weeks ago, it was 6.17 percent.The benchmark 15-year fixed-rate mortgage fell 31 basis points, to 5.45 percent. The benchmark 5/1 adjustable-rate mortgage fell 33 basis points, to 5.81 percent. The benchmark 30-year, fixed-rate jumbo mortgage, for home loans greater than $417,000, fell 17 basis points, to 7.03 percent.The 30-year fixed hasn't been this low since Sept. 21, 2005, when it was 5.88 percent. You have to go all the way back to June of 2000 to find the last time the rate on the 30-year fixed tumbled more in one week. In the second week of that month, the 30-year fixed fell from 8.56 percent to 8.28 percent in one week.Distributed by Scripps Howard News Service. Reach Marcie Geffner at editors(at)bankrate.com.