Congress passed a bill on January 1, 2013, which President Obama then signed into law on January 2, 2013, The American Taxpayer Relief Act of 2012 (Sec. 202), which extends the Mortgage Forgiveness Debt Relief Act through December 31, 2013. This legislation extends dozens of other tax cuts that have expired or are set to expire at the end of the year, including one that extends homeowners’ ability to deduct the cost of mortgage insurance on a qualified personal residence.
Under the federal tax code, all types of forgiven debt are treated as income, subject to regular taxes. Because of the Mortgage Forgiveness Debt Relief Act, homeowners who get their mortgage debt forgiven through either a short sale or loan modification won’t be taxed on the amount forgiven up to $2 million.
This law was set to expire December 31, 2012, placing a great deal of uncertainty on struggling homeowenrs, real estate agents and tax advisors. If it hadn’t been extended, any forgiven debt would have been considered taxable income, which would be devastating for homeowners who are already experiencing financial hardships.