The Mortgage Forgiveness Debt Relief Act of 2007 (“Act”) provides for an exemption for tax on debt forgiveness of money used to purchase, or make improvements to, a principal residence. In other words, if a mortgage lender voluntarily forgives debt when approving a short sale, or involuntarily forgives debt after a foreclosure, there is no tax owed by the homeowner on the debt forgiveness. In other words, if the mortgage loan is $200,000, and the home sells at a short sale or at a foreclosure for $120,000, the debt forgiveness of $80,000 is currently not taxable under the Act. This exemption is scheduled to expire December 31, 2012. If the exemption expires, the homeowner, who is usually already in financial trouble, will have to pay income tax on the $80,000 debt forgiveness.

In this election year of 2012 both Republicans and Democrats have supported the recovery of the real estate industry, and both Republicans and Democrats have supported tax cuts for the average home owner. Therefore, the real estate industry has thought that this exemption will be extended for at least two years after December 31, 2011.

Many conservative Republicans, however, oppose debt forgiveness for “underwater” homeowners. In fact, the current Speaker of the House, John Boehner, voted against the Act in 2007. Their reasoning is that “good” homeowners who have honored their mortgage loans are basically “picking up the tab” for defaulting “bad” homeowners who recklessly borrowed to buy overpriced homes. The exemption is expensive; the cost is estimated at $2.7 billion if the extension is extended for another two years.

Therefore, some political observers believe that in this current political climate the prospects for an extension of the exemption after December 31, 2012, are less than 50-50.

Inasmuch as the exemption is scheduled to expire in a little more than 9 months, the benefits of a short sale or foreclosure now should at least be contemplated by “underwater” homeowners.