Foreclosure tax penalty on renting of my primary residence in Washington state?

[MPT30A]

My wife and I are really concerned that the IRS is going to tax us us for "foreclosing on business real estate property" ! After a year of pleading to the mortgage company to help modify my loan, and failing to do the short sale route, I ended up foreclosing on a house that I rented out. I lived in it a few years prior to moving out and renting it to some friends. My question is, what tax penalties do I have to pay? I paid $225,000 for it in 2005. When I stopped making my mortgage payments in January of 2011, I had a principle balance of $200,000. The mortgage company sold it later for $130,000. I filed for an extension this year so I can sort things out on what to do about this mess on the foreclosure. being that I first purchased the home as a primary residence, is it now considered business property because we only rented it for a couple of years?

[Evan Bedard]

Welcome and thanks for joining the community.

Since you have lived in the property within the last few years it may still be considered your primary residence once the foreclosure is complete. Have you purchase a new home since then or is this the only property you currently own?

[MPT30A]

My wife owns the home where we both live in now. We each bought separate homes when we were split up back in 2005.