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On December 20, 2007, President Bush signed legislation, the Mortgage Forgiveness Debt Relief Act of 2007. The Act was written in response to some of the tax issues that have arisen as a result of problems in the subprime mortgage market. This legislation was written to help homeowners avoid foreclosure by protecting them from higher taxes when they refinance their mortgages. The Act creates a three-year period of time for homeowners to refinance their mortgages and pay no taxes on any debt forgiveness that they receive. In other words, if a lender forgives a portion of the mortgage, the amount forgiven will not be taxed.

The Act should increase the incentive to borrowers and lenders to work together to refinance loans. It should allow homeowners to secure lower mortgage payments without the threat of paying higher taxes.

Under the rules for debt forgiveness, (a) the debt must have been discharged by the lender in 2007, 2008 or 2009; (b) the amount of debt that can be excluded is limited to $2 million; (c) the exclusion can be used only if the loan was taken out to acquire, build or substantially improve a principal residence (Forgiveness of debt on vacation homes, second homes and investment property does not qualify); (d) Debt forgiven on a cash-out refinance or home equity loan must be apportioned between the amounts used for home acquisition, construction or improvements and amounts used for other purposes such as tuition, travel or repayment of other debts. Only the allowable portion qualifies for the tax break.

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