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New taxes on forgiven mortgage debt to hit owners

(MoneyWatch) Soon homeowners facing a short sale or foreclosure will have to pay federal income tax on any portion of the loan that is forgiven unless Congress intervenes.

The Mortgage Debt Relief Act Congress, passed in 2007, will expire at the end of the year. For the past five years, homeowners who conducted a short sale, are in foreclosure or restructured their mortgage and had part of the principal balance forgiven didn't have to pay any income tax on the forgiven debt.

But starting in 2013, homeowners who short sell their $150,000 home for $120,000 will have to pay taxes on the $30,000 worth of debt that was forgiven, because the federal government considers it income, even though homeowners never actually put any of this "phantom" income in their pockets.

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The legislation was initially passed to help homeowners struggling to pay their mortgage when the housing market crisis first began. But the market is still far away from recovery and real estate agents and legislators alike have argued that homeowners are still struggling and need relief.

"Homeowners facing a short sale or foreclosure are already in financial distress and are most likely unable to pay additional taxes," said Moe Veissi, president of the National Association of Realtors, in an e-mail. "These individuals have suffered through an economically devastating short sale or foreclosure of their home, and in many instances are unable to pay additional taxes, which only adds to their overall burden."

NAR is lobbying Congress to extend the tax relief past the 2012 deadline. Several legislators have introduced bills in both the House and Senate that would extend the tax relief.

The senate bill introduced by Democratic Senator Debbie Stabenow of Michigan would extend tax relief through 2013, while a House bill sponsored by Republican Representative Tom Reed of New York would extend the relief a year and another bill sponsored by Democratic Representative Charles Rangel, also of New York, would extend it two more years.

Though the three bills vary on how long they will continue the tax relief, they are all nearly identical in their goal to keep forgiven debt from a short sale, foreclosure or refinancing untaxed. All three bills have gone to committee. If the House and Senate are unable to come to an agreement, millions of homeowners could potentially wind up paying income tax on their mortgage deficiencies.

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