There was a settlement as part of a foreclosure counterclaim. The multi-year foreclosure itself was stopped via an internal trial modification that led to a permanent modification, but at that point the principal balance was much higher than the original principal because they added missed payments, taxes, insurance, etc.

According to the counterclaim, the bank orchestrated the foreclosure and forced acceptance of the modification (complete with the higher principal) in order to keep the house. Thus, the compromised settlement damages were based on the increased principal balance and the attorney fees involved.

So the question is: Would the settlement be non-taxable, taxable as income, an adjustment to cost basis, or something else entirely? If it makes a difference, the property started as a primary residence, but has been acting as a rental property for the last few years, complete with depreciation deductions.

Thanks!