Thanks to Denise Wing of Academy National Mortgage for this information:

Thanks to some last minute maneuvers in Congress, the Mortgage Debt Relief Act was extended through the end of 2013 as part of the deal reached by lawmakers to avoid the fiscal cliff. The law was set to expire at the end of 2012. Legislators left in place a 2007 tax break for homeowners whose debt is forgiven by lenders and preserved exemptions for profits on home sales.
Mortgage debt that’s been forgiven by lenders in short sales or loan workouts is typically taxable, which means money coming out of borrowers’ pocketbooks. Short sales are deals in which homeowners sell their properties for less than they are worth as long as banks approve. Help arrived in 2007, when the Mortgage Forgiveness Debt Relief Act came to be, giving people a break from taxable income on loan balances of up to $2 million, or $1 million for a married tax filer who’s submitting a separate return.
This move will help keep momentum going for a housing market that last year started to reverse a five-year slump that pushed the U.S. economy into the longest recession since the 1930s. The law helps the housing market by reducing the number of foreclosures. Repossessions are also down by one third compared to their highest levels in 2010.
Consumer advocacy groups would like to see a provision that excludes loans in which borrowers tapped their home equity while refinancing to be dropped because it creates a large paperwork burden for everyone who claims an exemption.
It is believed by many analysts the expiration of the mortgage-debt relief act could have led to serious economic consequences for parts of the nation. Possible outcomes included a surge in bankruptcies and foreclosures because certain borrowers would have been stuck with a tax bill after a short sale or loan modification. This could also have led to a reduction in the number of homes available in the market as consumers would have attempted fewer short sales and simply let their homes go back to the lender.
Since there are some situations were a tax liability could still be incurred, please consult your tax professional about the consequences of completing a short sale or home loan modification.
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