In 2007, Congress passed the Mortgage Debt Forgiveness Act of 2007 to help homeowners whose homes have been foreclosed or negotiated loan principal reductions.

Before this law, if your home was foreclosed and your home was sold for less than you owed, you would be taxed on the difference as if it were income. This was also true if your mortgage company agreed to reduce your loan balance – the difference would have been taxable.

Wow! That could be a lot of money for some people in certain parts of the country in some cases as high as 35% depending on your income. If it was 35% and your home’s mortgage was reduced through negotiation or foreclosure by $100,000, you would owe $35,000.

The new law says that if you renegotiate your morgage (or forclose) through December 31, 2012, there will be no taxes to pay on the amount of debt that was cancelled up to a $2 million dollar limit and it must be your primary home. If debt is forgiven on a second home or rental property, you will have to pay taxes on the amount of debt forgiven.

One more wrinkle is that if you refinanced your home and took cash out to pay for credit card debt, autos or other purchases, you may not qualify for the forgiveness. Check with your tax preparer to find out all the details.