The federal tax exclusion for forgiven mortgage debt on a primary residence expired on January 1, 2026, after repeated extensions since 2007. Unless Congress passes a new extension, mortgage debt forgiven in a 2026 short sale is generally taxable income by default.

This is a genuinely important update, and one that a lot of short sale information still circulating online hasn’t caught up to. For close to two decades, the assumption that short sale debt forgiveness is tax-free has generally held. As of right now, that assumption no longer holds automatically.

What changed and when

The Mortgage Forgiveness Debt Relief Act of 2007 originally excluded forgiven mortgage debt on a primary residence from federal taxable income. It was set to expire repeatedly over the years and was extended each time, most recently covering debt forgiven through December 31, 2025, or forgiven later under a written agreement signed before that date. No further extension has been passed as of now, so debt forgiven through a short sale closing in 2026 is, by default, treated as ordinary taxable income unless another exception applies.

Ordinarily, when $600 or more of debt is cancelled by a creditor, the IRS treats that amount as income to the borrower, reported on a Form 1099-C. That’s the rule the now-expired exclusion was specifically carving an exception out of for primary-residence mortgage debt.

The exceptions that still exist

An insolvency exception remains available: if a homeowner’s total liabilities exceed their total assets at the time the debt is cancelled, the cancelled amount can be excluded from income to the extent of that insolvency, claimed using IRS Form 982. Borrowers who file bankruptcy are generally presumed insolvent for this purpose and typically avoid the tax altogether through that route.

What this means for someone considering a short sale this year

It doesn’t mean every short sale closing in 2026 results in a tax bill. It does mean the old assumption, that forgiven mortgage debt is automatically tax-free, can no longer be relied on without checking. Anyone considering a short sale on their primary residence in 2026 should talk to a tax professional before closing, not after, so they understand whether the insolvency exception applies to their situation or whether they should plan for the forgiven amount as taxable income.

Have a question about your own situation? Call or text Michele Lee Scherger at 561-309-2950. As a Certified Short Sale Expert, she can walk you through what applies to your loan, your lender, and your timeline.

This is a genuinely important and very current change (confirmed: MFDRA exclusion expired 1/1/2026, no extension as of this writing) — strong candidate for its own featured post, since most other short sale content online is still describing the old, expired rule. Worth checking again closer to publish date in case Congress acts.