Mortgage Modifications Qualify for Debt Forgiveness If Entered into Before January 1st

(Parker Tax Publishing December 2016)

The IRS has issued a notice providing that qualified principal residence debt will still be considered discharged under the exclusion in Code Sec. 108(a) if, before January 1, 2017, a mortgage loan servicer sends a borrower-homeowner a notice in conjunction with a written Trial Period Plan (TPP) under the Principal Reduction Modification Program (PRMP) or the Home Affordable Modification Program (HAMP), even if the related mortgage modification occurs after that date. Notice 2016-72.

Under Code Sec. 108(a)(1)(E), the discharge of indebtedness income related to a discharge of qualified principal residence debt (i.e., a mortgage on the taxpayer's home) is generally excludable from gross income. Qualified principal residence debt is debt that is incurred to buy, build, or substantially improve the principal residence of the taxpayer and that is secured by that residence, and also includes a loan secured by the borrower's principal residence that refinances the debt, but only to the extent of the amount of the refinanced debt.

Observation: The maximum amount of discharged debt that a borrower may exclude from gross income under the qualified principal residence debt exclusion is $2,000,000 ($1,000,000 for a married individual filing a separate return).

The Protecting Americans from Tax Hikes Act of (PATH Act) extended the relief under Code Sec. 108(a)(1)(E) to arrangements entered into and evidenced in writing before January 1, 2017, in order to protect a borrower-homeowner who is in the process of obtaining a permanent modification of the mortgage loan during 2016, although the permanent modification of the mortgage loan resulting in discharge of indebtedness would not occur until after 2016.

The Principal Reduction Modification Program (PRMP) offers mortgage loan modifications to certain seriously delinquent, underwater borrower-homeowners who are still struggling in the aftermath of the 2008 financial crisis. The PRMP is a targeted, one-time offering for borrower-homeowners whose loans are owned or guaranteed by Fannie Mae or Freddie Mac and who meet specific eligibility criteria. For a borrower-homeowner to take advantage of the PRMP, the mortgage loan servicer must solicit the borrower-homeowner's participation by sending the borrower-homeowner a notice of PRMP eligibility in conjunction with a written Trial Period Plan (TPP) or, for a borrower-homeowner in an active TPP, a separate notice of PRMP eligibility in a written opt-out letter. If the conditions set out in the TTP are satisfied within a required time frame, then the borrower-homeowner is offered a permanent modification of the terms of the mortgage loan. The modification includes monthly mortgage payments that are lower than or equal to those under the old mortgage loan and, generally, a principal reduction. The Home Affordable Modification Program (HAMP), currently available through the end of 2016, offers a similar program to help distressed borrower-homeowners lower their monthly mortgage payments.

Notice 2016-72 provides that, for purposes of the exclusion for qualified principal residence debt, such debt is discharged "subject to an arrangement that is entered into and evidenced in writing before January 1, 2017" within the meaning of Code Sec. 108(a)(1)(E)(ii) if:

(1) before that date, a mortgage servicer sends a borrower-homeowner under the PRMP a notice in conjunction with a written TPP or, for a borrower-homeowner in an active TPP, a separate notice in a written opt-out letter outlining the terms and conditions of the permanent mortgage loan modification following completion of the active TPP;

(2) the borrower-homeowner satisfies all of the Trial Period and PRMP Conditions; and

(3) the borrower-homeowner and servicer enter into a permanent modification of the mortgage loan on or after January 1, 2017.

A similar conclusion applies to a TPP under HAMP.

For a discussion of the qualified principle residence debt exclusion, see Parker Tax ¶76,125.

For a discussion of the Home Affordable Modification Program, see Parker Tax ¶72,330.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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