Taxes · IRS Publication 4681Short sale and foreclosure taxes in 2026: canceled mortgage debt and what still excludes it

When a lender accepts a short sale or forecloses and forgives the rest of the mortgage, the forgiven amount is generally treated as income, and the lender may send Form 1099-C – which must be reported even if the form never arrives, unless an exception or exclusion applies (IRS Publication 4681). For years, homeowners could exclude forgiven debt on their main home as qualified principal residence indebtedness. The 2025 edition of Publication 4681 says that exclusion ends: qualified principal residence indebtedness can't be excluded from income for discharges completed, or discharge agreements entered into, after December 31, 2025; it was available for discharges before January 1, 2026. Two exclusions still apply: debt canceled in a title 11 bankruptcy case, and debt canceled while you were insolvent – your total liabilities exceeded the fair market value of all your assets immediately before the cancellation – to the extent of the insolvency, figured on the publication's Insolvency Worksheet; excluded amounts reduce tax attributes on Form 982. How the loan is structured matters too. With a recourse debt (you're personally liable), a foreclosure is treated as a sale at the property's fair market value, and any debt canceled above that value can be ordinary income. With a nonrecourse debt, the whole debt counts as the amount realized on the sale and doesn't create ordinary income from canceled debt, though there can still be gain or loss. For a seller, this means a 2026 short sale on a main home can carry a tax bill that earlier short sales didn't. The IRS posts any legislation enacted after the publication at IRS.gov/Pub4681.