The Mortgage Forgiveness Debt Relief Act of 2007 (the Act) was passed by Congress on December 18, 2007, and was signed into law by President Bush on December 20, 2007. The primary objective of this new law is to help beleaguered homeowners avoid foreclosure by eliminating the adverse federal tax consequences associated with debt forgiveness. The Act also extends the deduction for mortgage insurance premiums through 2010, expands the time period for a surviving spouse to use the higher home sale exclusion, and excludes from income certain state and local tax breaks given to volunteer emergency responders.

Foreclosure Relief
Generally, amounts of a debtor that are discharged are included in gross income. The Act generally allows taxpayers to exclude up to $2 million ($1 million if married filing separately) of mortgage debt forgiveness on their principal residence.

• Principal residence indebtedness includes indebtedness (for first, second, and home equity loans) that is incurred in the acquisition, construction, or substantial improvement of an individual's principal residence and that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing doesn't exceed the amount of the refinanced indebtedness.
• The basis of the taxpayer's principal residence is reduced by the excluded amount, but not below zero.
• The exclusion doesn't apply to the discharge if the discharge is on account of services performed for the lender, or any other factor not directly related to a decline in the value of the residence or to the taxpayer's financial condition. The exclusion also doesn't apply to a taxpayer in a Title 11 bankruptcy.
• This provision is effective for indebtedness discharged on or after January 1, 2007 and before January 1, 2010.

Extension of Deduction for Mortgage Insurance Premiums Paid
Premiums paid or accrued by a taxpayer during 2007 for qualified mortgage insurance in connection with acquisition indebtedness with respect to a qualified residence of the taxpayer are treated as deductible qualified residence interest (subject to a phase-out based on the taxpayer's AGI). The Act extends the rules treating qualified mortgage insurance premiums as deductible qualified residence interest for three years.

• This provision is effective for amounts that: (1) are paid or accrued after December 31, 2007 and before January 1, 2011; (2) aren't properly allocable to any period after December 31, 2010; and (3) are paid or accrued with respect to a mortgage insurance contract issued after December 31, 2006.

Modification of Exclusion of Gain on Sale of Principal Residence
A qualifying taxpayer may exclude up to $250,000 ($500,000 for joint return filers) of gain from the sale or exchange of property that the taxpayer has owned and used as his or her principal residence. Married taxpayers filing jointly for the year of sale may exclude up to $500,000 of gain if: (1) either spouse owned the home for at least 2 of the 5 years before the sale, (2) both spouses used the home as a principal residence for at least 2 of the 5 years before the sale, and (3) neither spouse is ineligible for the full exclusion because of the once-every-2-year limit on the exclusion.

• Prior to the Act, the maximum $500,000 exclusion was available only if a husband and wife filed a joint return for the year of sale. If the home was sold in a year after the year of a spouse's death, the surviving spouse could only get a maximum exclusion of $250,000.
• The Act allows surviving single spouses to qualify for the maximum $500,000 exclusion if the sale occurs not later than 2 years after their spouse's death and the requirements for the $500,000 exclusion were met immediately before the spouse's death.
• This provision is effective for sales and exchanges after December 31, 2007.

New Exclusion for Volunteer Emergency Responders
Generally, reductions or rebates of property taxes by state or local governments on account of services performed by members of qualified volunteer emergency response organizations are taxable income to the volunteers.

• The Act provides an exclusion from gross income to members of qualified volunteer emergency response organizations for:
  1. any "qualified state or local tax benefit"; and
  2. any "qualified payment"
• A "qualified state or local tax benefit" is any reduction or rebate of state or local income, real property, or personal property taxes on account of services performed by individuals as members of a qualified volunteer emergency response organization. To avoid a double tax benefit, the amount of state or local taxes taken into account by a taxpayer in determining his deduction for taxes is reduced by the amount of any qualified state or local tax benefit.
• A "qualified payment" is a payment that is provided by a state or political subdivision on account of the performance of services as a member of a "qualified volunteer emergency response organization". The amount of these payments is limited to $30 multiplied by the number of months during the year that the taxpayer performs such service (therefore, the maximum exclusion in a given year is $360 ($30 x 12 months)).
• A "qualified volunteer emergency response organization" is any volunteer organization which is: (1) organized and operated to provide firefighting or emergency medical services for persons in the state or its political subdivision; and (2) required, by written agreement, by the state or political subdivision to furnish firefighting or emergency medical services in the state or political subdivision.
• This provision is effective for tax years beginning after December 31, 2007 and before January 1, 2011.