In Washington, much of the political conversation these days surrounds a "fiscal cliff" of tax increases and budget cuts that could ignite another economic recession if lawmakers don't reach a compromise on such issues before this year ends. The National Association of Realtors warns about a law set to expire this year potentially affecting one-quarter of all real estate transactions -- the expiration of Mortgage Forgiveness Tax Relief".

Walter Molony, a spokesman for the association,  said "without action before the end of the year, millions of families who hold distressed properties could face a hefty tax bill for trying to modify their mortgage or to seek a short sale through their lender. Even those facing foreclosure will find themselves forced to pay a "foreclosure tax" if Congress doesn't act."  A "foreclosure tax," Molony said that "is our term to highlight that a family would face income tax on the amount of the loan forgiven after a foreclosure."

In late 2007, Congress passed the Mortgage Forgiveness Debt Relief Act to help the rising number of homeowners whose finances were being demolished by foreclosures. The act prevents homeowners from being taxed for the cancellation of any debt by a lender during a loan modification or foreclosure. The federal act applies for the years 2007 through 2012.

An example: "You borrow $100,000 and default on the loan after paying back $20,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $80,000, which generally is taxable income to you."

Generally, the debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify, the IRS says.

The maximum amount of debt a homeowner can claim is $2 million or $1 million if you're filing a tax return as a single payer. In 2011, the estimated tax savings to borrowers from the exemption was at least $1 billion, The New York Times reported, quoting calculations by the association.

Some estimates show short sales account for 20 percent to 25 percent of all homes sold in recent months across the country. Slightly more than 4 percent of U.S. homes were in foreclosure, according to a Bloomberg article published in August.

It's unclear whether Congress will pass any legislation to extend the act. Some National Association of Realtors officials believe Congress will pass an extension at the last minute. A one-year extension would cost the federal government about $1.3 billion, according to some estimates.

The active listing inventory dropped another 290 homes in the first two weeks of November and now stands at 3,753 units , 24% below the prior low record established in March 2005, when everybody had a hard time navigating with just 4,912 homes on the market.  Unbelievably that was an additional 1,159 more homes than today.

These inventory lows are unprecedented and are starting to apply upward pressure on housing values.  Quite simply, everything that is coming on the market below $750,000 that is priced right is flying off the shelves.  Buyers are now willing to pay a few thousand dollars above the last closed sale.  Closed sales are establishing higher prices throughout Orange County. 

However, buyers are not going to pay an additional 10% above the last comparable sale no matter sellers desire or needs.  Homes are appreciating at a very slow rate, not thousands of dollars every month.  Regardless of the craziness of today’s market, buyers are still not ready to pay well above recent comparable sales. 

The distressed market has also dropped, unabated since the end of October last year, when it totaled 3,563 units.  It has dropped by 3,073 units and now totals just 490 units.  The distressed inventory has not been this low since May 2007.  It currently represents just 13% of the total active inventory and 34% of demand.  Last year it represented 37% of the inventory and 56% of demand.  As yet there is seems to be little sign of the much reported “shadow inventory” waiting to make its way onto the market