Until now (12/07), if the value of your house declines and your bank/lender forgives a portion of your mortgage (via a short sale or deed in lieu), the tax code treats the amount forgiven as ordinary taxable income.  For a borrower already financially strapped, this makes a bad situation worse. When you're worried about making your payments, higher taxes are the last thing you need to think about. 

On December 20, 2007 the “Mortgage Forgiveness Debt Relief Act of 2007” became Public Law No: 110-142.  The law is retroactive to January 1, 2007 and will extend until December 31, 2009.  The passing of this bill creates a three-year window for homeowners to either refinance their mortgage or sell, and pay no taxes on any debt forgiveness that they receive.

The newly-enacted relief for mortgage debt forgiveness is Congress’s response to the problems generated by the subprime crisis, short sales, rising foreclosure rates and price corrections in some markets.  Thus, when a lender forgives some portion of a borrower’s mortgage debt in a short sale, a foreclosure, a workout with the lender or some similar circumstance, the borrower will NOT be required to recognize income or pay tax on the forgiven amount.

It will help many homeowners with adjustable rate mortgages that have seen their monthly payments increase faster than their ability to pay and face the prospect of foreclosure.

The law also makes PMI (private mortgage insurance) temporarily deductable.  These changes combined with FHA’s (Federal Housing Administration) new relaxed rules and enhanced flexibility to refinance loans are some of the step recently enacted to help struggling homeowners avoid a foreclosure.

Use this link from GovTrack.us to read the complete bill: