The mortgage debt forgiveness provision spares underwater borrowers from being penalized by the Internal Revenue Service when they agree to complete a short sale or when mortgage debt is cancelled as part of a loan modification.
Industry and consumer groups have been calling for a two-year extension of the Mortgage Debt Forgiveness Relief Act that would be retroactive to Jan. 1.
Senate Finance Committee chairman Ron Wyden, D-Ore., included such a two-year extension in his tax bill unveiled Tuesday.
"Congress' failure to extend mortgage debt forgiveness last year has created a situation where the federal government is now spending money on programs to prevent foreclosures, while threatening to tax the very homeowners they are trying to help," according to a letter signed by 23 industry and other interest groups.
"This threat of being taxed on 'phantom income' from debt forgiveness is causing many homeowners to think twice before modifying their loan or completing a short sale. Instead, they are choosing to continue on a path toward foreclosure or to simply walk away," the March 31 letter says.
While the Senate Finance Committee is on track to approve the tax extender bill quickly, it is unlikely to reach the president's desk any time soon, according to analysts at Guggenheim Securities.
"We believe Congress is unlikely to complete work on the extenders package until late this year. It could come down to December," analyst Jaret Seiberg wrote in a report on the tax extender bill.
Chairman Wyden's tax bill also would extend the deduction for mortgage insurance premiums for two years.
The two-year extension of the Mortgage Debt Forgiveness Relief Act is estimated to cost $5.4 billion over 10 years, according to the Congressional Budget Office. The MI premium deduction is estimated to cost $1.8 billion over 10 years.