Does Principal Reduction affect Capital Gains calculation?

[Corbin Lane]

During the 08 crisis I qualified for a HAMP loan mod that included a large principal reduction as my home was 50% below purchase price. I also had filed bankruptcy around the same time, and later found out that the lender who had supplied my 2nd mortgage (covering the down payment) had apparently discharged the loan - either due to the bankruptcy or the HAMP mod, very little information was given to me about why. The home that I had purchased for around 500k was now worth 250k, and I now only owed 250k. Currently the home is worth around 620k, my loan is paid down to 195k, and I'm thinking about selling the home to leverage out the proceeds of that sale into properties that better fit my goals. My question is whether either of the principal reductions would affect the way Capital Gains is calculated on my sale, or would it still only count as a $120k gain? The answer to this question would determine whether I need to worry about doing a 1031 or simply sell.

[Corbin Lane]

Thank you @Michael Plaks for bringing this up, and @Dave Foster for explaining it in detail. I wasn’t looking forward to waiting another year before I can scale up.