The news isn’t good as we start the year: It isn’t just the big financial companies that are suffering from their debt colds.

More than 2 million homeowners are in trouble with their debt payments. And a new study shows that more than half of homeowners who become delinquent on their loan payments ultimately go into foreclosure.

The new Mortgage Forgiveness Debt Relief Act of 2007, signed into law at the tail end of last December, is supposed to provide some relief to those who sell their homes short — that is, sell for less than the mortgage amount. It is only valid for 2007, 2008 and 2009, according to Eric Smith, a spokesperson for the IRS.

Prior to the new law being signed, if your lender agreed to a short sale, the IRS considered the difference between what you sold for and what you owed taxable income.

So, just as you were starting to move on with your life, having lost just about everything, the following April 15th you’d have owed the IRS income tax on what amounted to phantom income.

While the new law helps with this not-so-small point, it doesn’t apply to everyone, including those homeowners who are facing foreclosure on a second home, vacation home, timeshare, fractionally-owned property or those who took out second mortgages to pay for anything other than the purchase of the property or an improvement to the property, such as a new car or college tuition, according to Bob D. Scharin, RIA Senior Tax Analyst from Thomson Tax & Accounting.

The Mortgage Debt Relief Act only applies to debt used to purchase or improve a primary residence, Sharin explained.

There is another provision in the IRS code that has perhaps wider application for today’s real estate marketplace: Insolvency.

According to Chet Burgess, an enrolled agent who owns Brookwood Tax Service, in Atlanta, “the law provides if the taxpayer is insolvent to the extent of the amount of debt, a short sale would not be taxable income.”

Insolvency could help someone facing foreclosure, Burgess said, whereas the new Mortgage Forgiveness Debt Relief Act would not.

To figure out whether you’re insolvent (for IRS purposes) Burgess suggests using form 433F, which is the “Collection Information Statement.” (Download IRS forms for free at One side of the form lists all of the assets and debts. The other side lists monthly income and expenses. You can fill out the form online and then print it, or print first and work on it by hand.

At the top, you’ll be asked for your bank information and lines of credit. This includes any savings accounts, IRAs, 401(k)s, Keoghs, SEP-IRAs, lines of credit, mutual funds and stock brokerage accounts. For each of these accounts, you’ll list the institution, the type of account, and the balance owed or value.

Next, you’ll list your real estate, including house, second home, investment property, timeshare, or other real estate. Box C asks you to list any other assets, including cars, boats, recreational vehicles, and whole life policies.

On the next page, in Box D, you’ll list your credit cards and any debt you carry on them. (Although the IRS doesn’t ask for it, it’s a good idea to list the interest rate you’re paying on these cards.)

Although you don’t need it for the insolvency calculation, the rest of the page (Boxes E, F, and G) ask you to put down how much you earn and how much it costs you to live (for your necessary expenses, not including high-definition cable).

Add up all of your assets and then all of your debts. If your debts exceed your assets, you are insolvent by that amount. In other words, you’ve calculated your net worth, and come up with a negative number.

Although retirement assets can’t be tapped in bankruptcy, they count when the IRS is considering whether you’re insolvent, Burgess explains.

“Even in collection cases, where you’re dealing with the IRS, if a taxpayer has a large sum in his or her 401(k), which the IRS cannot reach, by law, it is still included. The IRS revenue officer will suggest that the taxpayer borrow against their 401(k) or withdraw from an IRA, to pay that debt,” he explains. “But if a homeowner was in foreclosure and a bank were looking for assets, the bank would have no power to reach a 401(k) or an IRA in most states.”

If you’re facing foreclosure, you may want call your tax preparer or attorney for help.

Mortgage Insurance Premium Deduction

There were a few other last-minute changes to the tax code. The Mortgage Insurance Premium deduction, which was set to expire at the end of 2007, was extended.

The measure allows private mortgage insurance (PMI) payments to be treated the same as interest for the purposes of itemizing on your federal income tax return.

The key thing here is “acquisition indebtedness.” In other words, if you get a loan to buy your property, and you earn less than $100,000, and you itemize, you can deduct your PMI payment. But if you do a cash-out refinance and use the cash to pay off credit card debt, you can only write off the portion of the PMI payment that represents the amount you spent to buy the house.

For the definitions of home acquisition debt and qualified home, check out IRS publication 936, “Home Mortgage Interest Deduction.”