When thinking about restructuring a mortgage or even going through the foreclosure process, most homeowners are motivated by the bottom line-lower monthly mortgage payments or relief from burdening debt.
What most homeowners do not consider is that along with lower mortgage payments, they may receive an income tax bill from the Internal Revenue Service (IRS). The Internal Revenue Code, which embodies the federal tax laws, classifies some discharge or forgiveness of debt as taxable income.
In other words, if the bank agrees to foregive or reduce your principal on the mortgage you signed, then you may owe income tax on the foregiven portion of the mortgage. For example, say you restructure the mortgage on your New York State home and you consequently owe $30,000 less, that $30,000 is considered “income” and is potentially taxed. The idea is that if you borrow money, which is then not paid back, it is a debt that is not being paid back and is akin to receiving “free” money. The taxing authorities consider such foregiveness “income,” because you got the value, but are now not paying it back.