In 2007, the U.S. Congress approved a law that exempted as much as $2 million debt for tax foreclosure properties from taxable income if the debt is ensured by a principal home.

Previously, mortgage lenders invalidate a part of distressed homeowners? loan debt through short sale or debts for tax foreclosure properties can be totally erased. This debt is then considered taxable income. The break for distressed owners of tax foreclosure properties is extended until 2012.

For example, a borrower purchased a house for $500,000 in 2004 and then in 2008, the property reduced its market value to $350,000. His mortgage balance reached $450,000, and added to that, he lost his job. With no other means to pay his monthly mortgage loan and no opportunity to sell his property in the current troubled housing market, he returned the deed of his property to his mortgage lender.

Under the law, the mortgage lender can cancel about $100,000 of the debt which would leave the borrower with a loss of $150,000. However, if he qualifies for the principal home indebtedness, he can exclude about $100,000 of his canceled mortgage loan on his 2008 tax return. Ordinarily, loan is taxable before the implementation of the law.

Owners of tax foreclosure properties can use the Form 982 to report the nullification of his $100,000 debt. This means that instead of incurring a loss of about $150,000 due to the sale of his distressed property, he only suffered a loss of $50,000.

The borrower's tax will not be affected in any way because the loss he incurred from the sale of his principal home is not deductible.

However, there are exemptions to the tax relief law. They include vacation and second homes, refinancing for payment of other purchases, paying credit card debts and self-finance mortgages. Also, a debt released through bankruptcy is not considered as taxable income.

Thomson Reuters Senior Tax Analyst Robin Christian explained that the tax relief law only helps people who borrowed more than they could afford to pay. In a nutshell, foreclosure will not affect a borrower's 2008 tax due.