Here's the law
itself: (Section E is the one that applies)(a) Exclusion from gross income.--(1) In general.
--Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if--(A)
the discharge occurs in a title 11 case,(B)
the discharge occurs when the taxpayer is insolvent,(C)
the indebtedness discharged is qualified farm indebtedness,(D)
in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or(E)
the indebtedness discharged is qualified principal residence indebtedness
which is discharged before January 1, 2014.
26 U.S.C.A. § 108 (West)
Qualified Principal Residence indebtedness means DEBT ON THAT PROPERTY.
What you end up going out and doing with the dollars is irrelevant. AND there's no way to prove ... all they can do is look at the loan documents and see that it was this house that secured the loan