Definition

• The Mortgage Debt Relief Act was passed in December 2007. The goal of the act was to help taxpayers escape financial ruin because of a crashing housing market combined with soaring unemployment. It allows taxpayers to exclude "income" as defined by the U.S. Internal Revenue Service, from the discharge of debt on their primary residences, in their taxes, according to the IRS website.
  
  

History

• Prior to this legislation, when a homeowner, in a desperate attempt to avoid a foreclosure, sold his home at a loss, the difference between what the house was sold for and what the seller owed his lender was considered income by the IRS. As such, the homeowner had to pay taxes on this figure, even though he never received a penny from the home's sale. For a person who was already struggling financially, this added tax burden could drive him over the edge of financial ruin, notes the Loan Safe website.
  
  

Benefits

• The Mortgage Debt Relief Act did not change the fact that the IRS considers the debt forgiven by a lender in a short sale to be income. However, it allows taxpayers to avoid having to pay taxes on this amount, since they never received it to begin with, according to the IRS. This means that after short selling a home, a person can walk away and start fresh, without additional financial burdens related to the home.
  
  

Application

• The legislation applies to debt forgiven in calendar years 2007 through the end of 2012 for the sale of a primary residence. The law caps the amount of forgiven debt eligible for exclusion at $2 million, or $1 million for individuals who are married but filing separately, notes the IRS website. While most commonly, short sales trigger the use of the protections in this law, the same protection is available to homeowners who had a portion of their mortgage debt forgiven as part of a loan modification agreement.
  
  

Exclusions

• This law does not apply to homeowners seeking debt forgiveness for properties other than their primary residences. Additionally, the protections afforded under this legislation do not extend to situations that aren't directly related to a decline in a home's value or a negative shift in a taxpayer's financial condition, according to the IRS.