Let’s say you’re $50,000 upside down and you decide on a short sale. Lets say the bank agrees to it and after months of paperwork and haggling you’re off the hook. You’re off the hook. Right? Well, not exactly. If you talk to a tax professional, they’ll tell you that Uncle Sam wants to tax that $50,000 forgiven debt as ordinary income. That’s right. Not only do you end up losing your home, the IRS treats the upside down portion as income to you and sends you a tax bill. Yikes.
Well that is about to change. The US Senate recently passed the Mortgage Cancellation Relief Act of 2007. This bill eliminates tax on forgiven debt (the $50,000 in the example above). However, keep in mind that this only applies on your principal residence, so if you are going to short sale or foreclose on an investment property be ready to cough up some dough to the IRS.
The House passed a similar bill earlier this year called the Mortgage Forgiveness Debt Relief Act of 2007 (HR 3648). Now the two bills will be reconciled and sent to the President for his signature. There is optimism in some quarters that this will happen before Congress breaks for the holidays. President Bush is in support of this bill and should sign it as soon as it reaches his desk. I guess anything that rids the world of tax is good for Mr. Bush! 
Not that is matters to the vast majority of us, but the bill caps the untaxable forgiven mortgage debt at $2million.
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Update: Mortgage Forgiveness Debt Relief Act of 2007
Mortgage Forgiveness Debt Relief Passes US House
Mortgage Forgiveness Debt Relief Act of 2007
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on Dec 21st, 2007 at 6:37 pm
The link for the Mortgage Cancellation Relief Act of 2007 (HR 1876) points to govtrack.us status of the Mortgage Forgiveness Debt Relief Act (HR 3648). That is a little mix up on your links.
THis is the correct link:
http://www.govtrack.us/congress/bill.xpd?bill=h110-1876
on Dec 24th, 2007 at 9:40 am
This bill was just signed by the President on 12/20/07. Hopefully, this will help a lot of taxpayers in a time of dire need of assistance.
on Dec 24th, 2007 at 11:40 am
Mike,
Thanks for your follow up and link update.
on Dec 24th, 2007 at 11:40 am
[...] Bush signed the Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) last week. I have been off the computer for a few days, relaxing with family and [...]
on Jan 29th, 2008 at 1:01 pm
We have a first that is ok. We also have a second that we can’t seem to pay on time. It is 50,000/500 a month. We are up to date with first, but almost 3 mos behind on second. They say they are going to forclose if we can’t come up with the money fast. What can we do? Our interest on the first is 5.75 and we are ok with it. However, the 50,000 puts us upside down by that amount. Any suggestions? Thanks. T