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.
While I do not specialize in §108 of the code and have not read much case law on this topic, a friend asked me to look at a matter similar to the one submitted above. In reading the above emails, especially when considering the timing issues pertinent to another §108 exclusion, qualified real property business indebtedness under §108(a)(1)(D), there appears to be a strong argument that the qualified principal residence indebtedness exclusion may be available to a taxpayer even years after having moved out of their home, provided that the real property was in fact their home on the day the debt was issued. I agree and support many of Taxagent’s comments above, but I do not necessarily agree with Taxagent’s assumption that qualified principal residence indebtedness is defined by the date the debt is forgiven, rather than the date of debt issuance. By the qualified real property business indebtedness exclusion under §108(a)(1)(D), the excludable debt is specifically characterized at the time the debt is issued and clearly not characterized or defined by the date it is forgiven. The same argument, I believe, holds true for the §108(a)(1)(E) exclusion. See as follows…
The fundamental provision under §108(a)(1)(E) allows the exclusion provided that the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013. Under §108(h)(2) “qualified principal residence indebtedness” means acquisition indebtedness [within the meaning of section 163(h)(3)(B)]. Seeing this reference to §163, I was somewhat discouraged as I know this section refers to Qualified Residence Interest for taxpayers to deduct interest payments on their house, and if you move out of your house and collect rent, you cannot deduct mortgage interest payments under §163. However, looking closer at the definition of Qualified Residence Interest, it is defined “as acquisition indebtedness with respect to any qualified residence of the taxpayer.” For now, look past the definition of the acquisition indebtedness to the qualified residence, which is defined as the §121 principal residence, plus one more residence. Therefore, it is possible to have acquisition indebtedness and no home mortgage interest deductions because the taxpayer no longer lives in a qualified residence, such as if the taxpayer moves out of the home and rents the property. Using this same analogy, it would be possible to satisfy §108(a)(1)(E) because acquisition indebtedness exists, even though the house is not a qualified residence. Acquisition Indebtedness is actually defined under §163(h)(3)(A) as “any indebtedness which (I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (II) is secured by such residence.” If you combine the code language with the following IRS language, it appears that qualified principal residence indebtedness is defined on the day it was created, not determined on the day the debt is forgiven.
“The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.”
-IR News Release 2008-17 02/12/2008
"Qualified principal residence is any mortgage you took out to buy, build, or substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to build or substantially improve your main home...."
-IRS Publication 4681