With Congress consumed in finding a way to avoid the fiscal cliff, mortgage finance and housing groups are urging lawmakers not to forget to pass a tax extender bill that excludes principal reductions from taxation.

The Senate Finance Committee has already passed a bill that extends 27 tax provisions that are due to expire at midnight on Dec. 31.

Included in the bill is a mortgage debt forgiveness provision to ensure that borrowers who receive a principal reduction via a loan modification or short sale are not penalized by the tax man.

“We urge you to ensure renewal…before the end of this year in order to help as many underwater homeowners as possible,” according to a Dec. 12 letter signed by eight trade associations. 

Currently, the amount of mortgage debt forgiven in a short sale or loan modification is not taxed as ordinary income. But that could change on New Year’s Day.  

Congress is expected to be in session during the last week of December, which means last-minute action on the tax extender bill is possible. The Obama administration supports extension of the mortgage debt forgiveness provision.

“The president has made it a real priority to try to get that provision in the tax extension bill,” HUD secretary Shaun Donovan testified. “It is high priority for us,” he added.

The American Bankers Association, American Financial Services Association, American Land Title Association, Consumer Bankers Association, Credit Union National Association, Mortgage Bankers Association, National Association of Realtors, Financial Services Roundtable and Housing Policy Council signed the joint letter.

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