The Home Affordable Foreclosure Alternative (HAFA) program encourages lenders (banks) and borrowers (homeowners) to work together to avoid foreclosure. Under the programs, borrowers under water (owning a home worth less than the outstanding balance of the mortgage) received preapproved terms for a short sale. In other words, the lender agrees to accept less than the full amount of the mortgage balance. Homeowners also receive up to $10,000 for relocation assistance through HAFA.
Income from the cancellation of debt on a principal residence is tax free in 2016 (this rule expires at the end of the year unless Congress extends it). Whether the HAFA relocation payment is tax free is unclear because the IRS has not ruled on the matter. However, an argument can be made that it is a government payment to promote the general welfare. Government payments to promote the general welfare are not taxed. If the funds are used for moving expenses, the expenses are covered by tax-free payments could not be claimed as part of a moving expenses deduction.