Cancellation of Debt Income Relief
Generally, cancellation of debt (i.e. from a mortgage or other loan) is taxable income. The Mortgage Forgiveness Debt Relief Act of 2007 generally allow taxpayers to exclude from income the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiveness in connection with a foreclosure or short-sale qualify for this relief. Up to $2 million of forgiveness is eligible for this exclusion. The exclusion applies to debt used to purchase, build, or improve your principal residence. If you have refinanced in the past and used any of the proceeds for anything other than to build or improve your principal residence, the exclusion does not apply to that portion of the mortgage debt. Any amount excluded from income reduces the taxpayer's cost basis in the home. Caution: California has different set of rules for mortgage foregiveness. Both the federal and California provisions expire December 31, 2012.