PhotoThe “fiscal cliff” is not the only thing looming over taxpayers at the end of the year. If you received a mortgage modification or other financial aid that reduced your mortgage obligation, you might find it's a taxable transaction.

Under the federal Mortgage Debt Relief Act, in effect since 2007, mortgage debt that is forgiven after a foreclosure or short sale or through a loan modification provided to a homeowner in financial hardship may be excluded from a taxpayer’s calculation of taxable income. This exclusion only applies to mortgage debt forgiven on primary residences -- not second homes.

However, that law is set to expire at the end of this year and, with lawmakers focused on a deal to avert the fiscal cliff, the outlook for extending it is uncertain.


“It would be outrageous if Congress sticks unexpected tax bills to the very families who need help the most,” said Iowa Attorney General Tom Miller. “If Congress doesn’t extend this exclusion, it would discourage homeowners from taking part in the settlement we designed to help them. That would be a travesty.”

Miller is one of 42 state attorneys general who signed a letter to Congressional leaders, urging an extension of the tax break. His colleague, Maryland Attorney General Douglas Gansler, said failure to do so would harm efforts to stem foreclosures.

"I am urging Congress to extend this homeowner relief so families who are already suffering don't get an unexpected tax bill or become discouraged from participating in the historic National Mortgage Settlement," Gansler said. "Extension of this tax exclusion is estimated to save homeowners about $1.3 billion over the next two years. Unless Congress acts, any debt relief provided under the national settlement and other mortgage debt relief programs will likely be considered taxable income."

Bad timing

The expiration comes at a time when many homeowners are benefiting from the $25 billion national settlement agreement with the nation’s five largest loan servicing companies, which provides direct relief to homeowners. Many other banks across the country also offer mortgage modification and debt relief programs.

Gansler says there is some hope. An extension is included in the Family and Business Tax Cut Certainty Act of 2012, S. 3521, which recently passed the Senate Finance Committee with bipartisan support.

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