The only part that should be taxable is the forgiven part of the debt in block 1.That is the most that can be taxable. It could be less.Were they insolvent - that is, was the total of their debts larger than the Fair Market Value of their assets (including both the FMV of the property sold and the full amount of the related mortgage)? If so, to the extent they were insolvent, the forgiven debt is not taxable. There are a couple of other possibilities spelled out in IRC section 108. Another that comes to mind is the qualified real property exemption. That generally applies to real estate used in a business. And renting property is a business.If some of the firgiven debt is not taxable, then you'll probably need to adjust the basis of the property when figuring the gain or loss on the sale.This isn't a process for the feint of heart. It's complicated, and something on which even well-educated professionals have differing opinions.--Peter
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