Under IRS regulations, if you owe a debt to someone and they cancel the debt, the cancelled debt may be taxable. This was especially frustrating to homeowners who let their house go into foreclosure only to get a 1099 for the money written off from the bank.
In 2007, Congress passed the Mortgage debt relief act of 2007. This act generally allows taxpayers to exclude income from the discharge of a debt from their primary residence (up to $2,000,000.00 - See IRS Publication 4681).
In short, if you default on your primary residence, the cancelled debt is no longer taxable. However, cancelled debt on investment property, and other debts can be unless you file for bankruptcy.
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