The Home Affordable Modification Program (HAMP) was established a few years ago by the Departments of the Treasury and Housing and Urban Development to help homeowners who are underwater avoid foreclosure.
Since 2010, one of HAMP’s programs has been the Principal Reduction Alternative (HAMP-PRA). Borrowers who qualify for the program have their mortgage principal reduced by a predetermined amount (called the PRA forbearance amount).
A borrower qualifies for the HAMP-PRA program only if:
- the mortgage is not owned or guaranteed by Fannie Mae or Freddie Mac
- the borrower owes more than the home is worth
- the house is the borrower’s primary residence
- the borrower obtained the mortgage before January 1, 2009
- the borrower’s mortgage payment is more than 31 percent of gross (pre-tax) monthly income.
- up to $729,750 is owed on the 1st mortgage.
- the borrower has a financial hardship and is either delinquent or in danger of falling behind
- the borrower has sufficient, documented income to support the modified payment, and
- the borrower has not been convicted of a real estate related fraud or felony in the last ten years.
The end goal of the HAMP-PRA program is to reduce the borrower’s mortgage loan until the borrower’s monthly payment is reduced to a monthly payment amount determined under the HAMP guidelines.
The principal reduction occurs over three years. If the borrower continues to make timely reduced monthly payments on the loan over all three years, the entire PRA Forbearance Amount is forgiven.
To encourage mortgage loan holders to participate, HAMP makes an incentive payment (called a PRA investor incentive payment) to the loan for each of the three years in which the loan principal balance is reduced. These payments range from 18 percent to 63 percent of the principal amounts reduced.
Current plans call for HAMP to continue accepting new borrowers through the end of 2013. Well over 100 lenders who participate in the program.
The IRS has now provided guidance on the tax consequences for borrowers participating in the HAMP-PRA. (Rev. Proc. 2013-16.) The IRS says that the PRA investor incentive payments made to mortgage loan holders will be treated as payments on the mortgage loans by the U.S. government on behalf of the borrowers. Thus, these payments are not taxable to the borrowers.
However, if the PRA forbearance amount exceeds the amount of the PRA investor incentive payments made to the mortgage loan holder, the borrower will be required to include the excess amount in gross income as income from the discharge of indebtedness unless an exclusion applies. Fortunately, most borrowers will qualify for such an exclusion.
For example, a borrower will be eligible to exclude the discharge-of-indebtedness income from gross income if (1) the discharge of indebtedness occurs (i.e., the loan is modified) before January 1, 2014, and the mortgage loan is qualified principal residence indebtedness, or (2) the discharge of indebtedness occurs when the borrower is insolvent.
Borrowers who exclude the discharge-of-indebtedness income must report both the amount of the income and any resulting reduction in basis or tax attributes on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness.
To learn more about HAMP and the HAMP-PRA program, visit www.makinghomeaffordable.gov.