UPDATE: President Obama signed an extension of the Act until the end of 2016.
When debt is forgiven, the creditor usually writes that off their taxes creating taxable income for the borrower. That is the dirty little secret of debt settlement. The great news of settling credit card debt at 30 cents on the dollar can result in a rather large 1099 tax bill. Until recently the Mortgage Debt Relief Act of 2007 has prevented foreclosed homeowners from being hit with a huge tax bill. That tax break expired as of January 1, 2014.
Although, Congress often allows tax breaks to expire only to retroactively allow them, there is no guarantee that will happen in this case. Homeowners need to be aware that they may suffer another injustice on top of foreclosure- A huge tax bill. Although declaring insolvency may be an out, typically the IRS definition of insolvency is different than your own. As a result of this tax break expiration analysts expect fewer short sales and fewer loan modifications. Why would a borrower agree to a short sale if that means they are just going to get a huge tax bill?
If you are in foreclosure, this is certainly an item to keep an eye on. Currently there are proposals to extend the mortgage debt forgiveness through 2017; however, as of the publication of this article, nothing has passed Congress.