The last two years have created financial difficulties for many families, and this has led to an historic level of home foreclosures. In many cases, the sale of a foreclosed home does not yield enough money to pay off the mortgage. Before 2008, any debt forgiven by the mortgage holder would generally result in ordinary income to the borrower. However, relief is now available in these circumstances.
If you still have mortgage liability after foreclosure, any amount forgiven by the lender is generally ordinary income. However, for debt discharged on or after January 1, 2007 and before January 1, 2013, the debt forgiveness is treated as tax-free if the property is your primary residence. The limit on qualifying debt is $2 million ($1 million if married filing separately).
This provision also applies when mortgage debt for a primary residence is forgiven as part of a refinance or other loan modification.
