In 2007, President G.W. Bush signed the Mortgage Forgiveness Debt Relief Act into law. The Act exempts forgiven mortgage debt as the result of a foreclosure, loan modification, short sale, etc. Most people aren't aware that the IRS considers forgiven debt to be taxable income. Had the Act not been signed, millions of distressed homeowners would have lost their homes and been taxed for the privilege.
The Act is set to expire at the end of this year. There are currently two resolutions pending in the U.S. House and one bill pending in the U.S. Senate, but the lame duck session of Congress is rapidly approaching its end. I have personally seen this issue being reported by three sources, and it's not receiving any coverage in national news media. Dennis Rodkin of Chicago Magazine has written about this topic. So has David Dayden at Firedoglake. He links to a Huffington Post article, which rounds out the three.
Allowing the Act to expire at the end of the year would cause several immediate problems:
1. The short sale market would take a major hit. Short sales don't always guarantee that the bank will forgive the "short" amount owed, but this can be negotiated. If homeowners sell short and then also take a major tax hit due to the forgiven short amount, there is a major disincentive to attempt a short sale.
2. Principal reductions on loan modifications become a terrible idea. Through the end of this calendar year, a hefty principal reduction is one way to get a delinquent mortgage back on track. Not only does it help make payments more affordable, it also helps homeowners build some equity. If the Act is not extended, those principal reductions become taxable income, which is a major burden to a struggling homeowner's budget.
3. The already anemic National Mortgage Settlement would be gutted. Since the National Mortgage Settlement relies upon short sales and principal reductions, failing to extend the Act would turn relief under the settlement into a massive burden on homeowners.
Congress and the President are currently facing off regarding the fiscal cliff. The current legislative sessions for the House and Senate are slated to end on December 14 (with the Senate's actual end date TBA). The legislation that would extend the Act's tax exemptions may very well go unaddressed. If you're concerned about the issue, then contact your Congressperson and Senator.