Thanks for the gentle reminder.Bump for Diane.
Let's start with a couple of basics on foreclosure. Foregiveness of debt (FOD) is generally taxable. It's considered ordinary income. NOTE: Don't always assume that a property that is foreclosed on or has a short sale on it will have FOD. In some states (AZ is one) the mortgage company can still come after the borrower for the difference. In other words, you have a property with a $200K note on it and it's subsequently foreclosed on or otherwise sold for $150K. You may or may not have FOD. The company might still come after you for the $50K still due.
Then, the next thing to consider is whether you're going to meet one of the two exemptions. (1) If you are insolvent, you will not have to pay tax. In other words, you can prove that your liabilities exceed your assets. Note that you do not have to file BK to get this exemption - just have to be able to prove that you're upside down. (2) If it's your primary residence, there is no FOD. That's part of a recent new tax law. (and the one that took a home loophole away in the progress)
Let's say that you can't meet any of the above exemptions and the company is definitely not going to pursue the extra debt. In fact, you've received a 1099C for the FOD.
In the same example, let's say that it's $200K, which is exactly the amount you paid (just to keep it simple). Your basis would normally be $150K (because you had FOD that reduced the amount due and the basis) but because you had to pay tax on the FOD, your basis is now $200K. Yet the selling price is $150K. that means you have a loss of $50K. Unfortunately, it's a capital loss and the amount of loss is limited to the amount of capital gains + $3,000.
So in that year, you'd have to pick up $50K of ordinary income and only get a loss of $3,000 on your tax return. Of course, you'll have a capital loss carryforward, but that sure doesn't help in the first year.