Fiscal Cliff Deal Averts Tax Debt Crisis

The Mortgage Forgiveness Debt Relief Act of 2007 was due to expire at the end of 2012, but Congress’ fiscal-cliff deal has extended it until the end of 2013.  The law provides tax relief to homeowners who have had debt forgiven via a short sale or loan modification. Without the law, any forgiven mortgage debt would be treated as taxable income.

For example, an underwater homeowner in the 25% tax bracket could pay $12,500 in taxes for a short sale in which his house sold for $150,000, but he previously owed $200,000. With the tax break, the homeowner would not have to pay taxes on the $50,000 of forgiven debt. (source)

This law will continue to incentivize struggling homeowners to take steps to either resolve their mortgage issues by short selling their home or seeking a mortgage modification. Because homeowners won’t be saddled with taxes on any forgiven debt, they won’t feel hindered in their efforts to put their house back on the market. The extension of this law will also help to reduce the number of foreclosures on the market by making it easy for struggling homeowners to sell underwater properties for their market value and not the amount of mortgage debt they owe. The only other part of this equation is the availability of credit and the willingness of buyers to get back on the market in their search for housing. And both parts seem to be coming into alignment with market needs, making some analysts predict a steady recovery of the housing market over the next year or two.