Distressed homeowners who used the equity in their homes to finance debt consolidation or vacations will still face a tax penalty if a lender reduces their mortgage debt under the recently enacted Mortgage Forgiveness Debt Relief Act.Only the forgiveness of mortgage debt used to finance the acquisition of a borrower's primary residence and improvements to the property will escape being treated as ordinary income for tax purposes, according to a mortgage banking alert by two tax attorneys at K&L Gates. Attorneys Kenneth Wear and Roger Wise also point out that only borrowers who have lived in their homes for at least two years can qualify for tax relief. This provision weeds out speculators but it also denies relief for new homeowners who got in over their heads and defaulted early. Meanwhile, the tax relief measure "places no additional burden on lenders," the tax attorneys say. The borrowers have to determine whether they qualify for relief. Lenders simply provide borrowers with Internal Revenue Service Form 1099-C (Cancellation of Debt).

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