Unfortunately, the short answer to your question is yes....unless you can find a buyer for the home before the foreclosure goes through.
A Foreclosure is handled under the tax
code in the same way as if you sold the residence, meaning that you have a sales price, less your cost basis in the home, and then either a net gain or loss.
You may not use the $170K figure as your basis in the house. Instead you must use your actual cost basis (the purchase price of the house, plus the cost of any improvements you made during the time you owned the home. If you did the labor yourself instead of contracting it out, then you may not count the cost equivalent of your labor, but you may include the cost of any materials that you purchased over the years)
The bank will be issuing a 2012 Form 1099-AAcquisition or Abandonment of Secured Property
The main boxes that you will be interested in is box 2, which is the balance of the debt still owed, and box 4, Fair Market Value of the home.
However, how your figure the gain or loss on house sold (foreclosure is still a sale) is by subtracting the cost basis (as described above) from the sales price (which is the $ amount in box 2 of the 1099A.
If this results in a loss (which it sounds like it will)
then unfortunately, you may not take the loss on the sale/foreclosure on your tax return. Please see below for more in depth information.Publication 523 (2010), Selling Your Home
Again, I wish I had better news for you.