Is Forgiven Mortgage Debt Taxable Income?

When a lender forgives part or all of a mortgage, the process is known as a cancellation of debt. While this provides financial relief, it can also create a new tax obligation. The Internal Revenue Service (IRS) considers the forgiven amount to be income because you received an economic benefit by no longer having to repay money you borrowed. This means the canceled portion of your mortgage could be subject to federal income tax, which can be an unexpected liability for homeowners.

Understanding Canceled Debt as Taxable Income

When a lender cancels a debt, you must include the canceled amount in your gross income unless a specific legal exclusion applies. This is known as Cancellation of Debt (COD) income. Lenders that forgive $600 or more of debt must report it to you and the IRS using Form 1099-C, Cancellation of Debt. You should receive this form from your lender by January 31 of the year following the debt cancellation.

The figure in Box 2 of this form shows the total amount of debt discharged. Because the IRS is notified, this amount is expected to appear on your tax return. Failing to report this income without a valid exclusion can lead to a tax bill for the unreported income, plus penalties and interest.

Federal Exclusions for Forgiven Mortgage Debt

Several provisions can relieve you from reporting forgiven mortgage debt as income. The primary one for homeowners is the Qualified Principal Residence Indebtedness (QPRI) exclusion. This allows you to exclude canceled debt from income if it was used to buy, build, or substantially improve your main home and was secured by that home. This relief is available through 2025, with a maximum excluded amount of $750,000, or $375,000 if married filing separately.

Another path is the insolvency exclusion. You are insolvent if your total liabilities were more than the fair market value of your assets immediately before the debt cancellation. You can exclude canceled debt from income up to the amount by which you were insolvent.

Debt discharged through a Title 11 bankruptcy is also not taxable. This covers most debts canceled as part of a bankruptcy case, and the amount you can exclude is not limited to the amount by which you are insolvent. The bankruptcy exclusion takes precedence if the debt cancellation occurs within the bankruptcy case.

How to Report Forgiven Debt on Your Tax Return

If you qualify for an exclusion, you must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. This form must be attached to your annual Form 1040 tax return for the year the debt was canceled to notify the IRS which exclusion you are claiming. On the form, you will specify which exclusion you are using, such as the QPRI or insolvency exclusion.

Using an exclusion comes with a consequence known as the reduction of tax attributes. For the QPRI exclusion, you must reduce the basis of your principal residence, which is its cost plus improvements. Reducing the basis by the amount of the excluded debt may result in a larger taxable capital gain if you sell the home in the future.

State Tax Implications of Mortgage Forgiveness

Federal rules for excluding forgiven mortgage debt do not always apply to state income taxes. Each state has its own laws regarding “tax conformity,” which determines if it adopts federal tax provisions like the QPRI exclusion. As a result, forgiven mortgage debt that is excluded on your federal return could still be taxable income at the state level.

This can create a state tax liability even when no federal tax is due. To determine the correct treatment, you must verify your state’s position on canceled debt. This information can be found on your state’s department of revenue website, or you can consult a tax professional familiar with your state’s laws.