WASHINGTON — Here's some encouraging news for financially stressed homeowners across the country: The Senate Finance Committee has approved a bipartisan bill that would extend the Mortgage Forgiveness Debt Relief Act through 2013.


Why is this important? Several reasons: The debt relief law spares homeowners who receive principal reductions on their mortgages from being hit with hefty federal income taxes on the amounts forgiven. Without it, millions of owners who go through foreclosure or leave their homes following short sales would experience even more financial stress.

The law, which is set to expire Dec. 31, has also provided relief to thousands of people who have debt balances written off as part of loan-modification agreements and is crucial to the $25-billion federal-state robo-signing settlement with large banks. Some Capitol Hill analysts predicted that, along with a host of other special-interest tax benefits, an extension might have trouble making it through the partisan gantlet in an election year.

But the Senate committee managed to pull together enough votes Aug. 2 to pass the debt relief extension, after heavy lobbying by the National Assn. of Realtors and the National Assn. of Home Builders. The bill, which now moves to the full Senate for possible action next month, also would extend tax write-offs for mortgage insurance premiums for 2012 and through 2013 and continue some energy-efficiency tax credits for remodelings and home construction.

The mortgage debt relief extension could affect millions of families who are underwater on their loans, delinquent on their payments and heading for foreclosure, short sales or deeds-in-lieu of foreclosure settlements. Under the federal tax code, all types of forgiven debt are treated as ordinary income, subject to regular tax rates. When an underwater homeowner who owes $300,000 has $100,000 of that forgiven as part of a modification or other arrangement with the bank, the unpaid $100,000 balance would normally be taxable.

But in 2007, Congress saw the fast-mounting distress in the housing market on the horizon and agreed to temporarily exempt certain mortgage balances that are forgiven by lenders. The limits are $2 million in debt cancellation for married individuals filing jointly and $1 million for single filers. This special exemption, however, came with a time restriction. Without a formal extension by Congress, starting Jan. 1 all mortgage balances written off by banks would be fully taxable — a nightmare scenario that has had financially stressed homeowners worried for months.

Their apprehension increased when some policy analysts predicted that a Congress as fractious and dysfunctional as the current one would never get its act together to pass any tax bills until the closing moments of the lame-duck session expected after the November election. Even then, with issues like the mounting federal debt and draconian spending cuts scheduled for Jan. 1 taking precedence, smaller tax extensions such as mortgage debt relief might well be lost in the dust storms, experts predicted.

A few Republican policy strategists, including Douglas Holtz-Eakin, a former Congressional Budget Office director and economics advisor to Sen. John McCain's presidential campaign, speculated that tea party freshmen in the House might oppose the debt relief extension because they see it as another costly bailout funded by taxpayers. The estimated revenue cost to the Treasury for a two-year extension is $2.7 billion.

The mortgage insurance deduction is another key housing benefit that made it into the Senate committee's eleventh-hour extender bill. Mortgage insurance generally is required whenever home purchasers make small down payments, whether on conventional, private market loans or government programs. Under a provision in the tax code that expired in December, certain borrowers could write off their mortgage insurance premiums on their federal income taxes, just as they do with mortgage interest. To qualify for a full deduction, borrowers could not have adjusted gross incomes greater than $100,000 ($50,000 for married taxpayers filing separate returns).

The Senate's bill would extend the write-off retroactively to this past Jan. 1 and would continue it through 2013. In other words, no buyer or owner who planned to write off premiums during 2012 would be penalized, despite the expiration.

The outlook for the extenders: Given the popularity of the housing deductions and credits, look for supporters to press the full Senate for early action in September to get these issues settled before election day. If there are serious objections in the Republican-controlled House, however, then all bets are off until the lame-duck session, when election losers as well as winners get to write federal tax policy.

kenharney@earthlink.net

Distributed by Washington Post Writers Group.