IRS Tax Forgiveness Act

Home Foreclosure and Debt Cancellation

Tax laws change. Always confirm current IRS guidance and consult a CPA or tax attorney.

Updated May 2026 based on current IRS guidance for 2025 tax returns.

When a mortgage lender cancels, forgives, or discharges mortgage debt after a short sale, foreclosure, deed-in-lieu, or loan modification, the forgiven amount may be treated as cancellation-of-debt income. In many cases, the lender reports that amount to the homeowner and to the IRS on Form 1099-C, Cancellation of Debt.

For 2025 tax returns, qualified principal residence indebtedness may generally be excluded from gross income if the debt was discharged before January 1, 2026, or if the discharge was made under a written arrangement entered into before January 1, 2026.

Qualified principal residence indebtedness generally means mortgage debt used to buy, build, or substantially improve your main home, and the debt must be secured by that home. A refinance may qualify, but only up to the amount of the old mortgage principal that was used to buy, build, or substantially improve the home.

The maximum amount of qualified principal residence indebtedness that may be treated as eligible for this exclusion is $750,000, or $375,000 if married filing separately. The exclusion does not apply to debt canceled because of services performed for the lender or for reasons not directly related to a decline in the home’s value or the homeowner’s financial condition.

Important 2026 update: Under current IRS guidance, qualified principal residence indebtedness cannot be excluded from income for discharges completed, or discharge agreements entered into, after December 31, 2025. Other exclusions may still apply depending on the homeowner’s situation.

Current IRS references include Publication 4681, Publication 530, Topic No. 431, and the Form 982 instructions.

1. What is cancellation of debt?

If you borrow money from a lender and the lender later cancels or forgives the debt, the canceled amount may have to be included in income for federal tax purposes. When you borrowed the money, you were not taxed on the loan proceeds because you had an obligation to repay the lender. If that obligation is later forgiven, the IRS may treat the amount you no longer have to repay as income unless an exception or exclusion applies.

The lender is usually required to report canceled debt of $600 or more to you and to the IRS on Form 1099-C, Cancellation of Debt.

Here is a simplified example: if you borrowed $10,000, repaid $2,000, and the lender canceled the remaining $8,000, the $8,000 is generally cancellation-of-debt income unless you qualify for an exception or exclusion.

2. Is cancellation-of-debt income always taxable?

Not always. Common situations where some or all canceled debt may be excluded from income include:

  • Bankruptcy: Debts discharged in a Title 11 bankruptcy case may be excluded from income.
  • Insolvency: If your total debts were greater than the fair market value of your total assets immediately before the debt was canceled, some or all of the canceled debt may be excluded. Insolvency can be complex, so homeowners should speak with a qualified tax professional if they believe this may apply.
  • Qualified principal residence indebtedness: For 2025, certain canceled mortgage debt on a main home may be excluded if it meets the IRS timing, use, and dollar-limit rules.
  • Nonrecourse loans: If the lender’s only remedy is to take back the property and the lender cannot pursue you personally, a foreclosure may not create cancellation-of-debt income. It may still create other tax consequences.
  • Certain farm or business debts: Specialized rules may apply outside the typical homeowner situation.

3. What counts as qualified principal residence indebtedness?

Qualified principal residence indebtedness is mortgage debt used to buy, build, or substantially improve your main home, and the debt must be secured by that home. If the mortgage was refinanced, only the portion that replaces qualifying acquisition or improvement debt generally qualifies. Cash-out refinance proceeds used for other purposes may not qualify, although another exclusion, such as insolvency, may still apply.

4. What is the current IRS limit?

For discharges covered by the current rules, the maximum amount that may be treated as qualified principal residence indebtedness is $750,000, or $375,000 if married filing separately. This is lower than the older $2 million / $1 million limit that applied under prior versions of the law.

5. I lost my home through foreclosure or completed a short sale. Are there tax consequences?

There can be two separate tax issues:

  • Cancellation-of-debt income: If the lender forgives debt after a short sale, foreclosure, deed-in-lieu, or loan modification, the forgiven amount may be taxable unless an exception or exclusion applies.
  • Gain or loss from the transfer of the home: Foreclosures and short sales are treated like sales for tax purposes. A homeowner may have to determine whether there is a gain from the transfer. Losses from the sale or foreclosure of a personal residence are not deductible.

Some homeowners may qualify to exclude gain from the sale of a principal residence under the normal home-sale exclusion rules, separate from cancellation-of-debt rules.

6. How is cancellation-of-debt income from foreclosure generally figured?

For a recourse loan, cancellation-of-debt income is often based on the difference between the total debt immediately before the foreclosure and the fair market value of the property. The amount reported on Form 1099-C is generally taxable unless the homeowner qualifies for an exception or exclusion.

For a nonrecourse loan, the foreclosure generally does not create cancellation-of-debt income, but the full outstanding debt may be treated as the amount realized for purposes of figuring gain or loss on the property transfer.

Because loan type, state law, and the facts of the transaction matter, homeowners should review Form 1099-C, Form 1099-A if received, the settlement statement, and lender approval letters with a tax professional.

7. Can I claim a loss if I lost money on the foreclosure or short sale of my home?

No. Losses from the sale, foreclosure, or short sale of a personal residence are not deductible.

8. What if I do not agree with Form 1099-C?

Contact the lender. If the form is incorrect, the lender should issue a corrected Form 1099-C. Keep records related to the purchase of the home, improvements, refinancing, the short sale or foreclosure, lender correspondence, settlement statements, and the property’s fair market value.

9. How do I report an exclusion?

If you exclude canceled debt from income, you generally must file IRS Form 982 with your federal tax return. Taxable canceled debt is generally reported as ordinary income on your federal tax return, commonly on Schedule 1 for nonbusiness debt. The correct reporting depends on the type of debt, the type of property, and which exclusion applies.

10. Where else can I get tax help?

If you are having difficulty resolving a tax problem involving an IRS bill, letter, or notice, the Taxpayer Advocate Service may be able to help.

Some taxpayers may qualify for free or low-cost help from a Low Income Taxpayer Clinic. These independent organizations represent low-income taxpayers in tax disputes with the IRS.

Related IRS Resources

Disclaimer: This information is for general education only and is not legal or tax advice. Short sale tax treatment depends on the homeowner’s full financial picture, loan type, timing, insolvency, bankruptcy, and IRS rules in effect for that tax year. Speak with a qualified CPA, tax attorney, or enrolled agent before filing.