The Internal Revenue Service (IRS) has clarified that some homeowners who receive financial assistance from the federal government under the Home Affordable Modification Project (HAMP) will not be required to pay taxes on that support. Specifically, funds received from the U.S. Treasury Department’s Housing Finance Agency (HFA) Innovative Fund for the Hardest-Hit Housing Markets (The “HFA Hardest Hit Fund”) and the Department of Housing and Urban Development’s (HUD) Emergency Homeowners’ Loan Program are exempt from taxation.

These aid programs provide financial assistance to struggling homeowners, either by making payments on the homeowner’s mortgage loan or by providing financial support during an owner’s transition to lower-income housing. Since payments under these programs are not made in exchange for any service performed by the homeowner, they can be excluded from the homeowner’s gross income for tax purposes under the general welfare exclusion.

Homeowners and lenders also should not report any mortgage interest deductions or receipts for payments made by a government agency.

The IRS has confirmed it will not penalize any mortgage loan servicer who reports payments received on a mortgage interest statement in 2010. Servicers who report payments in 2011 and 2012 will also be excused, so long as the servicer notifies homeowners that the amounts reported have been overstated due to inclusion of government subsidy payments.

State housing finance authorities (HFAs) that fail to file and furnish a mortgage interest statement will be exempt from penalty in 2010. HFAs that fail to file in 2011 and 2012 will also be exempt if they provide, to each homeowner and to the IRS, a statement containing the homeowner’s name and taxpayer identification number (TIN), and a separate statement with the amounts paid by the HFA and the homeowner to the mortgage servicer under the homeowner aid program.

Re. “Guidance on Tax Consequence of Distressed Homeowner Payments Provided (IRS Notice 2011-14)