The federal Consolidated Appropriations Act of 2021 extended the Qualified Principal Residence Indebtedness (QPRI) exclusion through the year 2025. This tax break allows some taxpayers who've had mortgage debt forgiven—like after a foreclosure, loan modification, short sale, or deed in lieu of foreclosure—to exclude the canceled amount from their income for federal tax purposes. If you receive a 1099-C (Cancellation of Debt) form from your mortgage lender and the QPRI exclusion applies, you don't have to report the forgiven principal as income on your federal tax return, which is good news.
This extension is also good news for homeowners thinking about completing a loan modification, short sale, or deed in lieu of foreclosure through 2025 because debt that's forgiven as part of the transaction might not be subject to taxation.
If a mortgage lender forgives all or part of a borrower's debt as part of a loan modification or after a foreclosure, short sale, or deed in lieu of foreclosure, the I.R.S. generally includes the amount in the borrower's gross income. So, the forgiven debt could result in tax liability.
But if your forgiven mortgage debt qualifies for this exclusion, as of December 31, 2020, you can exclude up to $750,000 ($375,000 if married and filing separately). Before this date, taxpayers could exclude $2 million ($1 million if you're married and filing separately).
The QPRI exclusion was first introduced in the Mortgage Forgiveness Debt Relief Act of 2007, and I.R.C. § 108(a)(1)(E) was added to the Internal Revenue Code. The exclusion was set to expire on January 1, 2021, but was extended to January 1, 2026. The exclusion also applies to debts forgiven as the result of a written agreement entered into before January 1, 2026, even if the actual discharge happens later.
To learn more about this tax break and the conditions to qualify, review I.R.S. Publication 4681 on Canceled Debts, Foreclosures, Repossessions, and Abandonments.
Tax laws are complicated, and even if you don't qualify for the QPRI exclusion, another exception or exclusion could save you from having to pay taxes on canceled debt. Also, forgiven debt might affect your state taxes. If you received a 1099-C form indicating your lender forgave all or part of your mortgage debt, or if you're considering completing a loan modification, short sale, or deed in lieu of foreclosure that has tax implications, consider talking to a tax attorney or tax accountant to get advice specific to your circumstances.
Effective date: December 27, 2020