So am I interpreting the relief act and
what constitutes a principle residence
No, you are not. By way of background, IRC § 108(a)(1)(E) states that "qualified principal residence indebtedness which is discharged before January 1, 2013" is not included in the taxpayer's income. Instead, the basis of the home is reduced by the amount of the debt discharged (but not below zero). The effect of this provision is to defer the income until the home is sold, and to convert what would have been ordinary income to capital gain income, which is taxed at lower rates. This provision was added in 2007 during the Bush Administration, and the Congress stated its reason for the bill as follows: "The Committee believes that where taxpayers restructure their acquisition debt on a principal residence or lose their principal residence in a foreclosure, that it is inappropriate to treat discharges of acquisition indebtedness as income."
For the purpose of the exclusion in § 108(a)(1)(E), § 108(h)(5) states that "the term 'principal residence' has the same meaning as when used in section 121." IRC § 121 is the provision that excludes up to $250,000 of gain ($500,000 in the case of married taxpayers filing a joint return) on the sale of a home if the taxpayer both owned the home and lived in it as his principal residence for at least two of the 5 years immediately preceding the date of the sale. There some other limitations on this exclusion that are not relevant here. What you have done is equate qualifying for the exclusion with the definition of "principal residence." But that's not correct. Principal residence tells you what you must have owned and lived in for 2 of the last 5 years. It is thus just a part of what it takes to qualify for section 121. What Congress was saying in § 108(h)(5) is that it wants "principal residence" to mean the same thing for that provision that it does for § 121, not that you must qualify for § 121.
So, the issue is, what does "principal residence" mean under § 121? The statute does not actually define the term. What Congress was doing here adopting the definition the IRS had issued in regulations for § 121. Specifically, Treas. Reg. § 1.121-1(b) states:
----------------------... (b) Residence--(1) In general.
Whether property is used by the taxpayer as the taxpayer's residence depends upon all the facts and circumstances. A property used by the taxpayer as the taxpayer's residence may include a houseboat, a house trailer, or the house or apartment that the taxpayer is entitled to occupy as a tenant-stockholder in a cooperative housing corporation (as those terms are defined in section 216(b)(1) and (2)). Property used by the taxpayer as the taxpayer's residence does not include personal property that is not a fixture under local law.
(2) Principal residence.
In the case of a taxpayer using more than one property as a residence, whether property is used by the taxpayer as the taxpayer's principal residence depends upon all the facts and circumstances. If a taxpayer alternates between 2 properties, using each as a residence for successive periods of time, the property that the taxpayer uses a majority of the time during the year ordinarily will be considered the taxpayer's principal residence. In addition to the taxpayer's use of the property, relevant factors in determining a taxpayer's principal residence, include, but are not limited to--
The taxpayer's place of employment;
The principal place of abode of the taxpayer's family members;
The address listed on the taxpayer's federal and state tax returns, driver's license, automobile registration, and voter registration card;
The taxpayer's mailing address for bills and correspondence;
The location of the taxpayer's banks; and
The location of religious organizations and recreational clubs with which the taxpayer is affiliated.
That is the definition of "prinicipal residence." The other parts of § 121 about owning the home andl living in it for 2 out of the last 5 years are not relevant.
Under your facts, the condo was not your principal residence when it was foreclosed upon and hadn't been for nearly 3 years. As a result, it would not qualify for the relief of § 108(a)(1)(E). The bill was meant to help homeowners when restructuring debt on their current home or when they lose that home home to foreclosure. You didn't lose your home, you lost an investment property. However, you might still find relief in the insolvency exception of § 108(a)(1)(B). This assumes that the leftover debt after the foreclosure was actually discharged (i.e. forgiven/canceled). If the debt hasn't been discharged yet, there isn't any income yet to worry about.