Qualified Principal Residence Indebtedness: 2026 Rules and Exclusion

Forgiven mortgage debt on a home you live in was long shielded from federal income tax by the qualified principal residence indebtedness exclusion, but that shield expired on December 31, 2025. Debt discharged in 2026 or later is taxable income unless the discharge carries out a written agreement your lender and you entered into before January 1, 2026, or unless you qualify for the separate insolvency or bankruptcy exclusions, both of which remain permanent.¹ If you received a Form 1099-C in 2025 or an earlier year and paid tax you might not have owed, you can still amend that return.

The 2026 Expiration and What Still Qualifies

The exclusion first appeared in 2007 and was extended several times. The Consolidated Appropriations Act of 2021 carried it through December 31, 2025 and lowered the maximum excludable amount from $2 million to $750,000 ($375,000 if married filing separately).¹² No further extension is in effect.

One transition rule survives. If you and your lender signed a written agreement for a short sale, loan modification, or foreclosure before January 1, 2026, the actual discharge can happen after that date and still qualify.¹ The arrangement must be in writing; an informal conversation with your servicer does not count.

H.R. 917 has been introduced to make the exclusion permanent, but the bill has not been enacted.³ Unless that changes, mortgage debt forgiven in 2026 without a pre-2026 written arrangement is taxable income for federal purposes.

What Debt Qualifies

The debt must be acquisition indebtedness on your principal residence, meaning a loan used to buy, build, or substantially improve the home where you live most of the time, and secured by that home.¹ Only one property counts as your principal residence at a time, so forgiven debt tied to a vacation home, rental, or second home is never eligible. A home equity loan used to pay off credit cards or buy a car is not acquisition indebtedness either, even though the home secures it.

Substantial improvements are additions or renovations that increase the home’s value, extend its useful life, or adapt it for a new use, such as adding a room, replacing a roof, or upgrading plumbing. Routine maintenance and cosmetic repairs do not count.

Refinanced Mortgages

A refinance qualifies only up to the balance of the old mortgage immediately before closing. Cash pulled out during the refinance counts only if those funds went directly into a substantial improvement to the same home.⁴ Suppose you refinanced a $200,000 mortgage and took another $50,000 in cash. If you used the $50,000 to renovate the kitchen and add a bathroom, the full $250,000 qualifies. If you used it to buy a boat, only the original $200,000 qualifies, and any later forgiveness has to be traced between the qualifying and non-qualifying portions.

Dollar Cap

The maximum excludable amount is $750,000 for single, head-of-household, and joint filers, and $375,000 for married filing separately.² Anything forgiven above that cap is taxable as ordinary income. If a lender forgave $800,000 for a single filer, $750,000 is excluded and $50,000 lands on the return.

Claiming the Exclusion on Your Return

The exclusion is not automatic. Your lender will issue Form 1099-C reporting the discharged amount, and if you do nothing, the IRS treats the whole figure as taxable.⁵ Gather your original loan documents, refinancing paperwork, receipts for any improvements, and an estimate of the home’s fair market value at the time of the discharge or property transfer. If the lender took the home through foreclosure, you may also receive Form 1099-A.

File IRS Form 982. On Part I, check box 1e for qualified principal residence indebtedness, and enter the excluded amount on line 2.⁶ If you still own the home after the discharge, also complete Part II to reduce the home’s cost basis. Attach the form to your Form 1040.⁷ Keep your loan records, closing statements, and improvement receipts for at least three years after filing.

Basis Reduction Is the Trade-Off

Excluding the debt is not free if you keep the home. You must reduce your basis by the excluded amount, up to the current basis of the property (generally what you paid plus improvements).⁷ A lower basis means a larger gain when you sell. Say you bought for $300,000, added $50,000 in improvements, and excluded $100,000 of forgiven debt. Your basis drops from $350,000 to $250,000. A later sale for $500,000 produces a $250,000 gain rather than $150,000. The Section 121 home-sale exclusion may still cover it ($250,000 single, $500,000 joint), but any excess is taxed as capital gain.⁸ The exclusion defers tax more than it eliminates it.

Amending a Prior-Year Return

If you paid tax on forgiven mortgage debt in a year the exclusion was in force, file Form 1040-X and attach a Form 982 with box 1e checked, exactly as you would on an original return.² The deadline is three years from the date you filed the original return or two years from the date you paid the tax, whichever is later.⁹ Early filers count from the April deadline of that year, so a 2023 return filed in February 2024 can be amended through April 2027. Miss the window and the refund is generally gone.

The Insolvency Exclusion Is Still Available

For discharges after 2025 with no pre-2026 written agreement, the insolvency exclusion under Section 108(a)(1)(B) is often the way through. It is a permanent part of the tax code and has no expiration date.¹

You are insolvent to the extent your total liabilities exceed the fair market value of your total assets immediately before the debt is canceled. The exclusion covers only the amount of insolvency. If you owed $400,000 in total debts and owned $350,000 in assets, you were insolvent by $50,000. On $80,000 of forgiven mortgage debt, $50,000 is excluded and $30,000 is taxable.

The IRS provides an insolvency worksheet. Assets include everything you own at fair market value, including your home, vehicles, bank accounts, retirement accounts such as IRAs and 401(k)s, jewelry, furniture, and other personal property. Liabilities include mortgages, car loans, credit cards, student loans, personal loans, and past-due bills such as utility balances and back taxes.¹⁰ Retirement accounts count as assets even though early withdrawal might cost you a penalty, which catches many people off guard.

The trade-off is steeper than under the QPRI rules. You must reduce tax attributes in a set order: net operating losses, general business credits, capital loss carryovers, property basis, passive activity loss carryovers, and foreign tax credit carryovers.¹ Most homeowners have little beyond property basis, so the practical result often looks similar. Anyone carrying business losses or investment carryovers should run the numbers first. To claim the exclusion, check box 1b on Form 982, enter the excluded amount on line 2, and complete Part II for any attribute reductions.⁶

Bankruptcy Discharge

Mortgage debt forgiven in a Title 11 bankruptcy case is excluded from income under a separate permanent provision, with no dollar cap and no expiration.¹ If bankruptcy handled the discharge, neither the QPRI nor the insolvency route is needed. The same attribute reduction rules that apply to insolvency apply here.

Foreclosure Can Trigger Two Tax Events

A foreclosure or short sale can produce both cancellation-of-debt income and a capital gain or loss on the transfer of the home itself, treated like any other sale.¹¹ Whether there is a gain depends on how the home’s fair market value or the outstanding loan balance (the answer differs for recourse and nonrecourse debt) compares to your adjusted basis. Publication 4681 walks through those calculations.²

If there is a gain, Section 121 can shelter up to $250,000 ($500,000 for joint filers) provided you lived in the home at least two of the five years before the foreclosure.⁸ Any basis reduction from a prior QPRI or insolvency exclusion enlarges the gain, which makes Section 121 more likely to matter. Report both the cancellation and any gain or loss on your return regardless of which lender forms you receive.

1
Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
2
Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments
3
Congress.gov. H.R.917 – 119th Congress (2025-2026) Mortgage Debt Tax Relief Act
4
Legal Information Institute. 26 USC 163(h)(3) – Qualified Residence Interest
5
Internal Revenue Service. Form 1099-C – Cancellation of Debt
6
Internal Revenue Service. Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness
7
Internal Revenue Service. Instructions for Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness
8
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
9
Internal Revenue Service. File an Amended Return
10
Internal Revenue Service. Insolvency Determination Worksheet
11
Internal Revenue Service. Publication 523 (2025) – Selling Your Home