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It is IRS policy to tax forgiven debt you are personally responsible for as if it is income. Say, for example, your credit card company settled a $10,000 debt for 50 cents on the dollar. You’d have a debt forgiveness of $5,000, which the IRS would count as income, just like your wages.
The same policy held true for most mortgage debt until 2007, when Congress passed the Mortgage Forgiveness Debt Act. That ended the liability for many homeowners — but not all.
In general, if you lose your home to foreclosure or short sale, where you sell your home for less than you owe, the IRS won’t add insult to injury by counting the difference as income. At least until 2012.
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