Reminder: The Mortgage Debt Relief Act of 2007 is set to Expire December 31, 2012

The Mortgage Debt Relief Act of 2007 allows taxpayers to exclude up to $2 million of forgiven debt on their principal residence in calendar years 2007 through 2012 as long as the discharge of debt is directly related to a decline in the residence’s value or in the financial condition of the taxpayer.

The exclusion from income tax on the forgiven debt applies to taxpayers who short sell their home, have their homes foreclosed, or restructure their mortgage to have a portion of the principal forgiven. Without the exclusion, the forgiven amount would be considered income and would be taxable even though homeowners never actually see the money.

Tax writers in the House and Senate are pushing to extend a mortgage debt forgiveness relief provision that expires at the end of the year, saying a failure to do so will result in large tax liabilities for taxpayers that are already struggling.

The Senate Finance Committee approved a bipartisan bill before summer recess that would extend the Mortgage Forgiveness Debt Relief Act through 2013. This would be the second extension of the original bill. Without a formal extension by Congress, starting on Jan. 1 2013 all mortgage balances written off by banks will be fully taxable.


Update: On January 2, 2013, the ATRA tax laws were enacted which has extended the debt relief provision for an additional year.