Most taxpayers are unaware of the fact that if they owe someone money and that debt is forgiven, the IRS treats the forgiven debt as income to the taxpayer. In many cases such as when the debt is with a family member or friend or is a small amount, the IRS doesn’t know about it and may very well not even care. Where this seems to crop up and surprise people, though, is often when they have mortgage debt forgiven.
Traditionally, in the United States if a homeowner owed $200,000 on a mortgage and sold the property for $150,000, the mortgage company forgave the $50,000 debt that he could not pay. The IRS would then treat that $50,000 forgiveness as income which would create a substantial tax burden on the taxpayer which, in most cases, he or she was unable to pay. Over the last few years because of the economic difficulties in the U.S. and all of the foreclosures and short sales, Congress passed a law that essentially gave relief to these taxpayers known as the Mortgage Forgiveness Debt Relief Act, and it was put in place through 2012.
Congress has now extended that law through 2013. Without getting overly technical, the law mainly applies to sales where the lender has approved the sale of a home for less than the amount of the mortgage. This is often referred to as a short sale.