Debt reduction was slow to take off as a tool for preventing foreclosure, but as it has proved to be among the most effective types of loan modification, loan servicers have grown more open to using it. Moreover, while the acting director of the Federal Housing Finance Administration forbade the use of principal reduction on mortgages overseen by Fannie Mae and Freddie Mac, even though it would have saved those entities money, the recent appointment of a permanent director, Mel Watt, has raised the possibility that the ban will be lifted.
"We're finally hitting the sweet spot of principal reduction and mortgage resizing, and all of a sudden the tax relief sunsets," said Lou Tisler, executive director of Neighborhood Housing Services of Greater Cleveland, which helped Mr. Heil with his case. Clients now have to be warned that Congress may not reinstate the exemption, Mr. Tisler said.
Officials in many states have been urging Congress to reinstate the exemption. "It is inherently unfair for the big banks to be allowed to write off these payments while struggling homeowners are hit with new tax bills they can't afford," said Attorney General Martha Coakley of Massachusetts.
A bill in the Senate to extend the exemption has 19 co-sponsors, including two Republicans from states hit hard by foreclosures, Johnny Isakson of Georgia and Dean Heller of Nevada. In the House, Joe Heck, Republican of Nevada, is the bill's sponsor. His three co-sponsors are Democrats.
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In an interview, Senator Isakson said that forgiven debt was nothing more than "phantom income" and should not be taxed. He said it would be unfair to end the exemption for those families who have managed to hold on to their homes.
"It's certainly not a giveaway to anybody, it's not going to grow into some kind of entitlement — in fact, it's going to shrink as time goes by," he said. "These are the people who have tried the hardest to hang on to their homes and keep the economy strong."
The bill may suffer from a general fatigue over homeowner issues or a belief that the Treasury cannot afford to forgo the revenue. (The provision is estimated to cost the government $1.3 billion a year in tax revenues; by comparison, the mortgage interest deduction for homeowners is worth $70 billion a year.) There may also be a sense that the exemption is no longer urgent because the economy, and the housing market, are improving.
Elyse Cherry, chief executive of Boston Community Capital, disagrees.
Her agency runs a program that keeps families in their homes by buying them in short sales and selling them back to the occupants at a reduced price. "I keep talking about this in terms of the tale of two recoveries," Ms. Cherry said. "If you're in middle-class or upper-middle-class areas, things are coming back. When you look at urban and lower-income areas, they're not at all."
"If the problem's over," she added, "then put the exemption back into place and it won't get used much. And to the extent the problem is not over, then the people getting whacked with this tax are the people least able to afford it."
—By Shaila Dewan of The New York Times