Investors prospecting for "short sales" and other pre-foreclosure opportunities-along with the realty professionals who connect them with lenders and distressed home sellers-got a big helping hand last week from Congress and the White House.

Congress passed long-awaited legislation to prohibit the IRS from demanding income tax payments from home sellers whose lenders write off a portion of the outstanding debt balance owed on the loan.

The "Mortgage Forgiveness Debt Relief Act" zipped through the Senate and House in the final week of the Congressional session and was signed into law by President Bush December 20th.

Though earlier versions of the bill made the tax code change permanent, the final bill limits the relief to sales and other loss-mitigation transactions that occur before January 1, 2010.

The big plus for investors and Realtors here is that the legislation -- which took effect immediately -- should relieve fears among financially-stressed home owners that participating in a short sale will leave them exposed to heavy taxes the following year.

Under the law as it stood until last Thursday, delinquent home owners heading for foreclosure had to factor a mean-spirited federal tax code into their decisions on whether to participate in a short sale or other transaction involving debt forgiveness.

For example, under prior law, if a lender chose to write off $50,000 of mortgage principal to facilitate a sale, federal rules required it to file a Form 1099 to the IRS to alert it to the home sellers' $50,000 debt relief "windfall." The IRS would then go after the sellers -- essentially kicking them while they were down -- demanding income taxes on the debt forgiven along with penalties in some cases.

The sellers would not have received even a dollar of actual income -- it was all phantom income -- but they would be hit with a tax bill at their full regular rates as if they had pocketed $50,000.

Now that tax burden is totally off the table -- at least until 2010. In the meantime, investors and Realtors should encounter one less objection by home sellers to participating in a short sale. That, in turn, should be a win-win-win for everybody involved.

Lenders and home owners will avoid the financial losses inevitable in foreclosures. Investors should be able to acquire, renovate, rent out or resell houses at deeply discounted prices. And Realtors looking for a profitable niche in an otherwise lackluster market environment should find more deals to work with.

Published: December 24, 2007

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.