WASHINGTON — An obscure but critical provision for the housing industry is slated to expire at the end of the year unless Congress passes a bill to continue it in the next few weeks.

The banking industry is hopeful that the Mortgage Forgiveness Debt Relief Act will be extended during the lame duck session, warning that it remains vital to the recovery of the housing market.

The law, which passed in December 2007 with a five-year sunset provision, exempts borrowers from having to pay taxes on debt forgiveness, like principal reductions and short sales.

Such forms of debt cancellation are also a critical part of the $25 billion mortgage servicer settlement signed in February, meaning expiration of the law would also throw a wrench in that deal. The five largest mortgage servicers agreed to use a chunk of the settlement funds to provide relief to struggling borrowers.

"Given that it's absolutely integral to the health of the housing market as well as to the framework of the servicer settlement, I have a strong belief that it will extended during lame duck," said Isaac Boltansky, a policy analyst at Compass Point Research & Trading. "It's not something that has gained a lot of notoriety or attention from folks on the Hill, and that will allow it to progress easily."

While the law has generally flown under the political radar, it's also viewed as a key stimulus for the housing market, and has proven relatively popular with members of both parties. But what form the extension will take remains to be seen, observers said.

"That's what I'm concerned about — I don't see a vehicle at this point," Boltansky said.

There have been several standalone bills in the House and Senate to extend the provision for one or more years, sponsored by lawmakers including Rep. Jim McDermott, D-Wash., Rep. Tom Reed, R-N.Y., and Sen. Debbie Stabenow, D-Mich. But none of those bills have been approved by their respective committees.

A more comprehensive bill, the Family and Business Tax Cut Certainty Act of 2012, included a one-year extension of the law and passed out of the Finance Committee in August, but hasn't yet had a vote on the Senate floor.

One likely candidate is a bill addressing the so-called fiscal cliff, if and when Congress puts one forward.

"As Congress starts negotiating the fiscal cliff in earnest, there's no doubt there will be must-pass legislation that will include elements like this," Boltansky said.

Observers said the most likely scenario is the passage of a one-year extension for the law with no changes to eligibility requirements. Looking beyond 2013, it's not clear how long the tax exemption will ultimately last. Political support for the measure will likely diminish if the housing market continues to improve.

"Do I think this is the last [extension]? Probably not, but I don't know how much beyond that," said Edward Mills, a financial policy analyst at FBR Capital Markets and former Hill aide. "Under normal circumstances, the belief is that not just writing down debt, but also relieving the tax burden, is one step too far."

"It's a year-by-year decision. The further you are away from a crisis, the harder it is to get support for these types of initiatives," he said.

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