WASHINGTON – The $17 billion settlement that Bank of America reached with the Department of Justice on Thursday sets aside billions in aid for some troubled homeowners.
But those who accept the help could get hit with a hefty tax bill later.
As part of the settlement, the bank agreed to spend $7 billion on helping homeowners and their communities, some of which would be used to lower the mortgage balances of certain borrowers who owe more than their homes are worth.
The problem is that some of these underwater borrowers might have to pay taxes on the debt that’s forgiven.
In 2007, Congress adopted a law that spared homeowners from being taxed on the amount of the loan that was written off. But that tax break expired in December, and now that kind of relief can be counted as income by the IRS.
In negotiating the deal, the Justice Department recognized that many of the borrowers it was trying to reach would be in no position to accept the help if doing so would lead to a huge tax bill.
"That’s why the Department secured a commitment from Bank of America to pay a portion of the settlement – over $490 million – to defray some of this tax liability," U.S. Attorney General Eric Holder said in a statement announcing the deal. "And our settlement requires the bank to notify all consumers of the potential tax liability."
The Bank of America settlement includes a program that would reduce the size of a borrower’s mortgage so that the loan amounts to 75 percent of the value of the home, and the interest rate would be permanently set at 2 percent. Such principal reductions are considered one of the most effective ways to help underwater borrowers.
Associate Attorney General Tony West offered an example of using a homeowner who owes $250,000 on a house that’s worth only $150,000. Under the plan, the balance of the mortgage would be reduced to about $112,000. But the roughly $137,000 forgiven could be a tax liability.
To help pay such liabilities, the settlement has a 25/25 Tax Relief Fund.
"But it’s only a temporary fix; the fund isn’t large enough to cover every potentially affected consumer, which is why the best solution to this problem is for Congress to heed the attorney general’s call to extend the tax relief coverage," West said.