When a home is sold due to foreclosure or debt relief issues, the IRS has specific rules regarding whether the standard home sale gain exclusion applies. The criteria for taxpayers can be found below:

Sales Price Determination – When there is a foreclosure or voluntary reconveyance the sales price is determined based upon whether there is debt relief or not. Where the debt is a non-recourse debt the sales price is the balance of the loan at the time of disposition. Where the debt is recourse, the sale price is the FMV of the home at the time of disposition.

Debt Relief Basis Adjustments – There may be a home basis adjustment to be accounted for in a debt relief computation. Where the taxpayer excludes gain under the insolvent taxpayer exclusion there is no home basis adjustment. However, if a taxpayer utilizes the special homeowner’s exclusion for 2007 through 2025, then the homeowner must reduce the basis of the home for which the debt relief income is attributable. This basis adjustment must be reported on IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, by checking box 1e of Part I of that form and entering the amount of basis reduction on line 10b of Part II. This in effect transfers the debt relief to the home where it can be excluded under Sec 121, or if any portion of it is taxable, it becomes capital gains income.