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Housing recovery could also tumble off the 'fiscal cliff'

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If Congress drives the economy off the "fiscal cliff," wave goodbye to short sales that have helped the housing market get back on its feet.

At risk is?a provision that erases taxes on selling a home for less than what's?owed to?the bank.

Expiration of the tax treatment?would create a major new headache for the one in four homeowners who owe more than their house is worth. Those "underwater"?sellers would have to come up with a big check for Uncle Sam to pay the tax on the difference.

That ?would be a blow to the housing recovery,? said Paul Diggle, a housing economist at Capital Economics. ?The increased use of short sales, rather than foreclosures, has become an important support to the recovery.?

Currently, roughly a quarter of all home sales are short sales. ?There are several reasons?they've?become much more common in the aftermath of the biggest housing bust since the 1930s. ?

'Will all hell break loose?' Your fiscal cliff questions answered

The steep plunge in home prices left some 12 million homeowners owing more than their homes are worth. In a short sale, the lender accepts the proceeds as payment in full, writing off the remaining value of the loan.

Lenders have turned to short sales as a faster way of getting bad loans off their books. After a surge in foreclosures brought widespread complaints that lenders?weren't?fully reviewing documents, many states passed legislation that made it harder for lenders to seize homes.

?(A short sale) certainly seems to be the foreclosure alternative that has gained the most momentum in the past couple of years," said?Daren Blomquist, an analyst at?RealtyTrac, which tracks foreclosures.

The five biggest mortgage lenders also got a powerful incentive to forgive more mortgage debt following a $25 billion settlement in April with 49 states and the federal government. Under?a complex formula, the lenders earn credits against a portion of the settlement payment for each dollar of mortgage debt forgiven.

Banks extended $10.6 billion in relief from March 1 through June 30,?according to the?government official appointed to monitor the settlement. Some 140,000 homeowners got an average $77,000 each?in debt relief.

Bank of America Wednesday reported that some?62,000 borrowers have?completed short sales that saved?them?$7.4?billion?in debt, or an average of about $120,000 each.

Until the housing collapse, forgiven mortgage debt was taxed as ordinary income. Under those rules, a typical household would owe about $19,000 tax on the average settlement relief so far.

But in 2007, as the housing boom turned to bust, Congress passed the Mortgage Debt Relief Act, which shielded such forgiven debt from taxes. The law was extended in 2010 but is due to expire at the end of the year unless Congress acts to steer away from the so-called ?fiscal cliff.?

Separate bills have been introduced?in the House and Senate to extend the mortgage relief tax break for another year. The measure would cost about $1.3 billion in uncollected taxes. ?

The law is credited with helping pull the housing industry out of the worst recession in nearly a century. Though still deeply depressed, sales of both new and existing homes have been steadily rising. Home prices appear to have bottomed out and are rising again in many parts of the country.

Restoring the tax on debt forgiveness could throw cold water on one in four home sales by sticking the seller with a large tax bill.?

?If (homeowners) decide they that short sale is not the best option, and they just allow (the mortgage) to be foreclosed, that has a more negative impact on the neighborhood and on home values,? said?Blomquist.

That would be bad news for lenders, too. The average price of a bank-owned property seized in foreclosure is about $30,000 lower than comparable house transferred in a short sale. Banks also avoid the legal costs of seizing a home and the?extended cost of maintaining it.

?(A short sale) really does work out to both the borrower?s and lender?s benefit in most cases,??said Michael Fratantoni, a research analyst at the Mortgage Bankers Association.

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Source: http://www.nbcnews.com/business/economywatch/housing-recovery-could-also-tumble-fiscal-cliff-1C7077702

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