According to the Federal Trade Commission, a person facing foreclosure can give his house back to the bank with a deed in lieu of foreclosure. In exchange for signing over the deed to the home, the bank forgives the debt owed on the home.
When a debt is forgiven, the former homeowner must report the forgiven debt as income to the IRS, states the Federal Trade Commission. Although the income must be reported, the Mortgage Forgiveness Debt Relief Act of 2007 removes the tax liability for the amount of the forgiven debt. According to Bankrate, up to $2 million may be excluded; however, if a portion of the mortgage was used to pay for consumer purchases or to consolidate consumer debt, this portion of the loan is not excluded from the individual's taxable income.
As an alternative, the lender might agree to a short sale. According to the Federal Trade Commission, in a short sale, the homeowner sells the home and gives the proceeds to the lender. In exchange, the lender agrees not to foreclose on the home and to forgive the debt repaid by the sale. According to Bankrate, the amount forgiven is still reported as a partial charge off on the individual's credit report.