The bill, unanimously approved by the taxwriting Ways and Means Committee, would also permanently extend a tax deduction for private mortgage insurance.
Currently any debt forgiven in a foreclosure or loan renegotiation is considered taxable income.
Families dealing with the pain of a foreclosure should not have the double whammy of a large tax bill for terminating their mortgage through no fault of their own, Committee Chairman Charles Rangel, a New York Democrat, said in a statement.
The bill now goes to the House for consideration. The legislation was prompted by the subprime mortgage crisis that has left a growing number of home buyers unable to pay rising interest costs on loans.
To cover the the roughly $2 billion 10-year cost of the bill, the committee agreed to tighten rules on the tax treatment on the sale of vacation homes or rental property that were converted to a principal residence.