LARGO — When Mark Baer listed his Walsingham Heights home for sale, buyers offered $100,000 less than what he owed on his mortgages.
Baer, 50, believed he could persuade the bank to forgive the difference. But the deal posed a big risk: If not done by the end of the year, it could cost him $30,000 in taxes.
"If I do close before that deadline, I will feel like the luckiest man in the world," Baer said. "If you owe the government money … they can come take your last pair of sneakers. They could take everything."
Starting Jan. 1, underwater homeowners could be in for a painful surprise: The Internal Revenue Service will begin counting most forgiven mortgage debt as income that can be taxed.
Foreclosed? You'll be taxed on what's left on your mortgage. Win a write-down on your principal? You'll pay taxes on what was cut. Even short sales, the distressed market's new norm, will be taxed on what was still owed.
For example, if a bank reduces a mortgage principal by $100,000, that homeowner would owe taxes on that amount because it would be treated as income. A homeowner in a 20 percent tax bracket would owe $20,000.
The tax time bomb could serve as a costly new indignity for homeowners. The fallout would be particularly drastic in the Tampa Bay area, where the foreclosure rate remains high and nearly half of all mortgage holders owe more than their homes are worth.
It could also sludge up the housing market as it teeters toward recovery, real estate agents said. Spooked potential sellers could dodge the taxes by staying put in their homes. Instead of the confidence that comes with a fresh start, they would remain burdened by a financial anvil.
"If (tax relief) is not extended, you're going to get a bunch of people stuck in short sales … and they'll never be able to get out," said Keller Williams agent Steve Capen. "I don't think it would be good for anybody."
The change comes with the end of the Mortgage Forgiveness Debt Relief Act, passed by Congress in 2007 at the dawn of the housing bust. It allowed homeowners to write off the "phantom income" of forgiven debt but is set to expire Dec. 31.
The law allows homeowners to write off up to $2 million in mortgage debt this year, as long as it was spent on buying or improving a primary home.
The IRS will provide for some very limited exceptions after the provision's end, meaning most homeowners would have no chance to scrape past the tax unscathed.
Securing a deficiency waiver will keep bank collectors away, but not the IRS. Even a bankruptcy is not likely to remove the extra tax.
Congress has talked of an extension, but final approval is far from guaranteed in a polarized election year. Extending the provision for two years would cost the government more than $2 billion in tax revenue, Congressional Budget Office records show, at a time when Republicans and Democrats both crow about cutting deficits.
Beth Cromwell, a short sale processer with Hillsborough Title, is telling worried homeowners that she would bet on an extension.
"There's too many short sales that haven't even been approved yet," Cromwell said. "If they don't (extend), they're just going to create a wave of people filing for bankruptcy."
Others, like attorney Charles Gallagher, are more doubtful of an 11th-hour rescue. "I'm not real hopeful D.C. will come up with a fix by the end of the year," he said.
Lenders must forgive the debt by Dec. 31 for homeowners to make the cut, and short sales and other forgiveness measures can often take longer than 90 days to process.
"If you want to get in by the end of the year, you'd need to list your house today," and even then it might be too late, Capen said. "I have a feeling December is going to be a mess."
Drew Harwell can be reached at [email protected] or (727) 893-8252.