Miami Herald- Underwater Homeowners Hold Their Breath By KENNETH R. HARNEY Under the federal tax code, if a lender forgives mortgage debt as part of a loan modification or other arrangement, that amount will be treated by the IRS as ordinary income and taxed accordingly. Typically the tax bill runs into the tens of thousands of dollars. Owners who are currently negotiating or planning loan modifications or short sales involving cancellation of portions of what they owe in 2015 have no legal protection against big tax bills next year.