The Mortgage Foreclosure Debt Relief Act and Debt Cancellation -- Tax Implications
"If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief."
This IRS publication discusses commonly asked questions and answers about The Mortgage Forgiveness Debt Relief Act and debt cancellation. Applicable situations include (but are not limited to) short sales, principal reductions and forgiveness of deficiencies after foreclosures.