What Was the Mortgage Debt Forgiveness Act?
Understand the tax rules of the expired Mortgage Debt Forgiveness Act and how it affected income for homeowners with certain cancelled debt.
The Mortgage Forgiveness Debt Relief Act of 2007 allows certain taxpayers to exclude forgiven mortgage debt from their taxable income. Originally enacted in response to the subprime mortgage crisis, this tax relief has been extended for qualifying debt discharged through December 31, 2025. This law provides relief to homeowners who have a portion of their mortgage debt forgiven, often through a foreclosure, short sale, or loan modification. Without this act, the forgiven amount would be treated as taxable income.
Understanding Cancellation of Debt Income
Under federal tax law, when a lender forgives a debt you owe, the forgiven amount is considered income. This is known as Cancellation of Debt (COD) income, as the Internal Revenue Service (IRS) views it as an economic benefit since you are freed from the obligation to repay.
For example, if a lender cancels a $10,000 credit card balance, that forgiven amount is treated as taxable income for that year. You must report it on your tax return and pay taxes on it, similar to wages from a job. This principle applies to many forms of debt, including car loans and personal loans.
A mortgage is often the largest debt an individual holds, and its forgiveness can result from a foreclosure or a loan modification. The resulting COD income could be substantial, creating a large tax liability for a homeowner already in financial distress, which is the situation the act was designed to alleviate.
Qualification Requirements for the Exclusion
To benefit from the mortgage forgiveness exclusion, the forgiven debt must have been on the taxpayer’s principal residence. A principal residence is the home where you ordinarily live most of the time. Vacation homes, second homes, or rental properties are not eligible for this tax relief.
The debt itself must be “qualified principal residence indebtedness” (QPRI). This means the loan was used to buy, build, or substantially improve your main home and was secured by that home. If you refinanced your original mortgage, the exclusion is limited to the amount of the old mortgage’s principal balance just before the refinancing.
Any additional cash taken out during the refinance for purposes other than home improvement, such as paying off other debts, does not qualify for the exclusion. For example, if a homeowner’s original mortgage was $250,000 and they refinanced for $300,000, using the extra $50,000 to pay off student loans, only the original $250,000 portion of the debt is considered QPRI.
Calculating the Excludable Amount
The law sets specific maximums on the amount of forgiven debt you can exclude from your income. For debt discharged from 2021 through 2025, the maximum amount of excluded forgiven debt is $750,000. For a married individual filing a separate return, the limit is $375,000.
For instance, a married couple filing jointly with $800,000 of qualified mortgage debt forgiven can exclude $750,000 of the canceled debt from their income, but the remaining $50,000 would be taxable. If a single individual has $75,000 of mortgage debt forgiven, they could exclude the entire amount because it is less than their $750,000 limit.
How to Report the Exclusion on Your Tax Return
Reporting the exclusion begins when the lender sends the taxpayer and the IRS a Form 1099-C, Cancellation of Debt. This form reports the amount of debt discharged and alerts both parties to a potential income-reporting requirement.
To claim the exclusion, you must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, with your Form 1040. On Part I of Form 982, check the box on line 1e to indicate the exclusion is for qualified principal residence indebtedness. On Part II, line 2, enter the amount of the discharged debt being excluded, up to the applicable limit.
A consequence of taking this exclusion is that you must reduce the basis of your principal residence by the amount of the excluded debt. This basis reduction is reported on line 10b of Form 982 and would increase any taxable gain if the home were later sold for a profit.