Unless a newly introduced bill passes, a 2007 federal provision that allows taxpayers to exclude debt reduction income resulting from mortgage restructuring or foreclosure will expire at the end of the year.

The Mortgage Debt Relief Act of 2007 applies to debt forgiven from 2007 to 2012. Up to $2 million of a married couple’s forgiven debt is eligible for the exclusion ($1 million if married filing separately), which does not apply if the discharge is due to any reason not related to a decline in the home’s value or the taxpayer’s financial condition.

To extend the provision beyond its Dec. 31 expiration date, U.S. Reps. Jim McDermott, D-Wash., Shelley Berkley, D-Nev., and John Larson, D-Conn., introduced the Homeowners Tax Fairness Act to, as they put it, “protect homeowners and servicemembers who were wrongly foreclosed on and entitled to relief under the historic national mortgage settlement from additional tax burdens.”

The legislation extends the exclusion for the three-year period anticipated by the $25 billion foreclosure settlement agreement.

If the 2007 law expires, homeowners and servicemen who receive settlement payments and mortgage debt forgiveness for wrongful foreclosure after 2012 will be subject to federal income tax.

In an attempt to get mortgage servicers to act quickly, the foreclosure settlement allows servicers credit for more principal reduction than is actually provided under the settlement over the next 12 months. The nation's top five servicers are committed to achieving $10 billion in principal reduction credits under the agreement.

The agreement also requires servicers to meet 75% of $20 billion in relief within two years. That includes write-downs, modifications, short sales, forbearance and other actions.

The three lawmakers expect the bill to impact 1.7 million homeowners across the U.S., including 68,000 in Nevada, who are eligible to take part in this settlement.

The bill also extends the deduction for mortgage insurance for three years and excludes cash payments for wrongful foreclosure from income as well as payments to servicemembers wrongfully foreclosed on or overcharged mortgage interest in violation of the Servicemembers Civil Relief Act.

The federal government announced in February that major banks will reimburse military servicemembers for any wrongful foreclosures done in the past five years. JPMorgan Chase (JPM), Wells Fargo (WFC), Citigroup (C), and Ally Financial will resolve Servicemembers Civil Relief Act claims in connection to the wider foreclosure settlement.

“We need to protect homeowners and servicemembers who have already been the victims of fraud or unfair foreclosure practices from also being hit with a new tax bill resulting from this mortgage settlement,” Berkley said.

“This legislation will prevent homeowners in Nevada and nationwide who receive refinancing help, principal reductions or direct payments under this settlement from having to literally pay for the fraud and deception committed by banks and members of the mortgage industry,” she said.