PMI Deduction Revived, Extended

David  Mully
Written by
David Mully
Read Time: 2 minutes

Two tax protections for mortgage borrowers were extended for at least another year as part of the fiscal cliff agreement approved by Congress, while the mortgage interest deduction itself went untouched.

The last-minute agreement, passed by both the Senate and House on New Year's Day, extends through the end of 2013 a tax deduction for mortgage insurance premiums and a provision that exempts from taxation forgiven mortgage principle.

The tax deduction for premiums paid for mortgage insurance had expired at the end of 2011, but the fiscal cliff agreement retroactively applies it to premiums paid in 2012 and extends it through the end of this year as well. The original law applied only to mortgages originated in 2007 and later; that provision appears to have been unchanged in the extension.

Tax exemption for short sales, loan mods, foreclosures preserved

The law exempting forgiven mortgage principle from taxation expired at the end of 2012 but is now extended through the end of 2013. Prior to that law's original adoption in 2007, mortgage principle that a homeowner escaped liability for as a result of a foreclosure, short sale or loan modification could be treated as income for federal tax purposes.

For example, prior to the law's adoption, a homeowner who owed $200,000 on a mortgage and was allowed by the bank to sell the home through a short sale for $150,000 might have been required to count the $50,000 in forgiven debt as income for tax purposes. The extension of the law means that will not be the case for at least another year.

Could have limited short sales

Failure to extend that law could have put a crimp in short sales and the $25 billion mortgage servicing settlement agreed upon this year by major lenders and the federal and state governments. That agreement, a resolution of mortgage servicing violations related to the robosigning scandal, requires major mortgage lenders to provide billions in mortgage principle forgiveness to at-risk borrowers.

Short sales accounted for 22 percent of all residential home sales in the third quarter of 2012, according to RealtyTrac, a 17 percent increase from one year earlier.

Finally, the fiscal cliff legislation made no changes to the mortgage interest deduction, claimed by millions of homeowners. Restricting or eliminating the deduction had been advocated by many economists as a way of generating more tax revenue to help address the federal budget deficit, but in the end the popular deduction emerged unscathed.

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