If you negotiate with the creditor and all or part of the debt is forgiven or the debt would be canceled under bankruptcy protection procedure - you are sent the form 1099-C.
The amount of debt forgiven is reportable on 1099-C - http://www.irs.gov/pub/irs-pdf/f1099c.pdf - generally is taxable, unless an insolvency exemption apply -- you should file a form 982 - to proof your insolvency - and might exclude all or part of canceled debt from taxable income.
In additional - the Mortgage Forgiveness Debt Relief Act of 2007 allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence. You still need to file the form 982 to claim the exclusion.
More information, including detailed examples can be found in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.
Please consider this example.In 2002, Becky purchased a principal residence for $315,000. Becky took out a $300,000 mortgage loan to buy the principal residence and made a down payment of $15,000. The loan was secured by the principal residence. In 2003, Becky took out a second mortgage loan in the amount of $50,000 that she used to add a garage to her home.In 2008, when the outstanding principal of her first and second mortgage loans was $325,000, Becky refinanced the two loans into one loan in the amount of $400,000. The FMV of the principal residence at the time of the refinancing was $430,000. Becky used the additional $75,000 debt ($400,000 new mortgage loan minus $325,000 outstanding principal balances of Becky's first and second mortgage loans immediately before the refinancing) to pay off personal credit cards and to pay college tuition for her daughter.After the refinancing, Becky's qualified principal residence indebtedness is $325,000 because the debt resulting from the refinancing is qualified principal residence indebtedness only to the extent the amount of debt does not exceed the amount of the refinanced debt.
Let me know if you need any help.
That example is from IRS Publication 4681 that is referenced above.
I provided the example because it is very close to your situation.
If you exclude the canceled qualified principal residence indebtedness from income and you continue to own the residence after the cancellation, you must reduce the basis of the residence (but not below zero) by the amount of the canceled qualified principal residence indebtedness excluded from income. Enter the amount of the basis reduction on line 10b of Form 982.
Qualified principal residence indebtedness is any debt incurred in acquiring, constructing, or substantially improving your principal residence and which is secured by your principal residence. Qualified principal residence indebtedness also includes any debt secured by your principal residence resulting from the refinancing of debt incurred to acquire, construct, or substantially improve your principal residence but only to the extent the amount of debt does not exceed the amount of the refinanced debt.
Based on your information - seems as your debt is qualified for exclusion according to the Mortgage Forgiveness Debt Relief Act of 2007.