The Mortgage Forgiveness Exclusion After 2025: Who Still Qualifies and What to Use Instead

For almost two decades, homeowners who lost a house to foreclosure or got a principal reduction had a safety net. Canceled mortgage debt on a principal residence was usually excluded from income. Congress kept extending it, sometimes retroactively, and people came to treat it as permanent.

It is not. The current text of IRC 108(a)(1)(E) excludes qualified principal residence indebtedness only if the debt is discharged before January 1, 2026, or is discharged subject to an arrangement that was entered into and evidenced in writing before January 1, 2026. Unless Congress acts again, a foreclosure, short sale, or modification that is negotiated and completed entirely in 2026 or later will not qualify.

That does not mean every 2026 mortgage write-off is taxable. It means you need a different exclusion, or the written-arrangement rule.

How the exclusion works when it applies

Canceled debt is gross income under IRC 61(a) unless an exclusion applies. Section 108(a)(1)(E) provides the exclusion for qualified principal residence indebtedness. Section 108(h) supplies the rules:

• What debt qualifies. Acquisition indebtedness with respect to your principal residence, meaning debt incurred to buy, build, or substantially improve the home and secured by it. IRC 108(h)(2) applies a $750,000 limit ($375,000 for married filing separately).
• What a principal residence is. IRC 108(h)(5) borrows the meaning from IRC 121. A Sarasota condo you rent out, or a seasonal home in Venice you visit in winter while your main home is up north, is not your principal residence.
• Why the debt was forgiven. IRC 108(h)(3) denies the exclusion if the discharge was on account of services you performed for the lender or another factor not directly related to a decline in the home's value or your financial condition.
• Mixed loans. IRC 108(h)(4) says that if only part of a loan is qualified principal residence indebtedness, the exclusion applies only to the amount discharged that exceeds the non-qualifying part. A cash-out refinance that paid off credit cards is the classic mixed loan, and the non-qualifying portion is treated as forgiven first.
• Basis reduction. IRC 108(h)(1) reduces the basis of the residence by the excluded amount, but not below zero.

The written arrangement rule

The statute protects discharges that happen in 2026 or later if they are subject to an arrangement entered into and evidenced in writing before January 1, 2026. That language matters for anyone whose workout started in 2025 and finished later.

Examples of documents worth locating:

• A trial or permanent loan modification agreement signed in 2025 that provides for principal forgiveness
• A short sale approval letter issued in 2025, even if the closing slipped into 2026
• A written settlement agreement on a deficiency signed in 2025

A phone call with the servicer is not an arrangement evidenced in writing. Neither is an application that was still under review on December 31, 2025. If you are relying on this rule, put the document in your tax file and be prepared to show it.

What remains available in 2026 and later

Insolvency

IRC 108(a)(1)(B) excludes canceled debt to the extent you are insolvent immediately before the discharge. Under IRC 108(d)(3), insolvency is the excess of your liabilities over the fair market value of your assets. Homeowners in foreclosure frequently qualify, at least in part, because the underwater mortgage is a liability and the house is valued at its depressed market price. The calculation and its traps are covered in the insolvency guide.

Note the coordination rule in IRC 108(a)(2)(C). When both the residence exclusion and insolvency could apply, the residence exclusion takes precedence unless you elect insolvency instead. After 2025 that rule matters only for discharges that still qualify under the written-arrangement language.

Bankruptcy

IRC 108(a)(1)(A) excludes debt discharged in a title 11 case, and IRC 108(a)(2)(A) gives it priority over the other exclusions. Bankruptcy is a major decision with consequences well beyond taxes, but the exclusion is not limited by dollar amount or by solvency.

Nonrecourse debt

If your mortgage was nonrecourse, foreclosure generally does not produce canceled debt income at all. Under Treas. Reg. 1.1001-2, the full debt is treated as the amount realized on the disposition. A personal residence may then show a gain, which IRC 121 may exclude, or a nondeductible loss. See the recourse and nonrecourse guide.

Debt that was never forgiven

If the lender reserved its right to collect a deficiency, nothing has been forgiven yet. A Form 1099-C may still arrive under the reporting rules. Read the Form 1099-A and 1099-C guide before assuming you have income.

Planning a 2026 workout with taxes in mind

If you are negotiating with a lender now, the tax result belongs on the table alongside the deal terms:

1. Measure your insolvency before the discharge date. The test is immediately before the discharge. If you are close to the line, timing and the treatment of other debts can matter.
2. Know whether the lender is waiving the deficiency. A waiver creates canceled debt now. A reserved deficiency may create it later, in a year when you might be solvent.
3. Separate the qualifying and non-qualifying debt if any written arrangement predates 2026, because IRC 108(h)(4) treats the non-qualifying portion as forgiven first.
4. Do not forget the federal tax lien. If the IRS has a lien on the home, a short sale or deed in lieu needs a discharge certificate before it closes. See the short sale guide.

Reporting

Whichever exclusion you use, you claim it on Form 982 attached to your return. Part I, line 1e covers qualified principal residence indebtedness, and the form itself cautions you to read the instructions before checking that box for debt discharged after 2017. Line 1b covers insolvency, and line 1a covers a title 11 case. Part II handles the attribute and basis reductions. For a residence exclusion, line 10b is where the reduction to your home's basis goes.

If Congress revives the residence exclusion, it may do so retroactively, as it has before. If that happens, an amended return may recover tax paid on a 2026 discharge. Keep the documents that would support it.

The safety net has a date stamped on it now. Plan around the date, not the habit.