California state law already provides debt-tax relief, so owner-occupants here are covered.

Homeowners and banks are accelerating sales of properties for less than the amount owed as a U.S. law that gives them a tax break expires at the end of the year.

The transactions, known as short sales, increased by 35 percent in the third quarter from a year earlier, while sales of bank-owned homes dropped 20 percent, according to a report today by mortgage data seller Renwood RealtyTrac LLC. Together, they accounted for 41.5 percent of home purchases in the quarter.

Short sales have accounted for as many as 1.1 million transactions since 2009, helping to reduce the inventory of homes owned by banks that can blight neighborhoods and flood the market. Barring a last-minute extension of the 2007 Mortgage Forgiveness Debt Relief Act, homeowners will be taxed on the forgiven principal. With Congress focused on the so-called fiscal cliff, federal spending cuts and tax-rate hikes set to kick in on Jan. 1, the law may not be extended, leading to a drop in short sales and a rise in foreclosures.

“If you’re struggling to pay your mortgage, it’s not likely you can afford an extra $25,000 or $35,000 tax bill to avoid foreclosure,” said Edward Mills, a financial policy analyst at FBR Capital Markets in Arlington, Virginia. “Mortgage forgiveness has become part of fiscal cliff politics.”

The Internal Revenue Service typically taxes forgiven debt as income to the debtor. For short sales, the average price tag was $94,896 below the mortgage on the property, according to the RealtyTrac report. Tacking that onto borrowers’ income would not only raise the amount of taxes due — it could push them into a more expensive tax bracket.

The fate of the mortgage-forgiveness tax break is bound up in the negotiations over the so-called fiscal cliff, said Douglas Holtz-Eakin, chief economist to Bush’s Council of Economic Advisers in 2001 and 2002.

The mortgage debt forgiveness measure may be tacked onto the back of a broader bill that addresses the fiscal cliff, said Holtz-Eakin.

“There’s bipartisan support for extending the mortgage- forgiveness bill,” Holtz-Eakin said. “Not doing it is a recipe for bad politics.”

If the tax break isn’t extended, it’s going to come as a surprise to many homeowners currently negotiating a principal reduction with their lenders, said Elyse Cherry, CEO of Boston Community Capital, which provides foreclosure prevention aid in Boston.

“If you ask 10 people in foreclosure, most of them wouldn’t know they may have a deadline,” Cherry said. “They know about the fiscal cliff, but they don’t know they might be facing their own cliff.”


Pin It on Pinterest