• DYE CULIK PC | Consumer Protection Division

Loan Modifications with Principal Forgiveness No Longer Taxable for Most Homeowners Under Recent Law

If you get a loan modification that forgives some or all of your mortgage balance, the IRS probably won’t tax you for it. That’s the new rule according to recent Congressional action extending the Qualified Principal Residence Indebtedness (QPRI) exclusion. This may be a huge help if you are a homeowner struggling with mortgage payments because of the novel coronavirus (COVID-19), or for any other reason.

Normally, most debts that are forgiven are treated as income by the IRS, which means they’re taxed as income – just as if you had actually put those forgiven dollars in your pocket. Creditors who forgive debts typically notify you of this with an IRS Form 1099.

Well, not anymore, at least for the years 2018 to 2021. Forgiveness of mortgage debt up to $2 million, as long as it is for your principal residence, is no longer taxable.

This QPRI exclusion had previously been allowed to expire after the mortgage crisis had ostensibly ended. Reenacting it will be a huge help to homeowners who were already struggling with their mortgages, as well as those who may soon be struggling because of economic hardships caused by COVID-19.

Who does the QPRI exclusion help? It helps homeowners who (1) had part of their mortgage forgiven via a loan modification, or (2) went through a foreclosure and had their balance forgiven. The last thing you need after you come through a financial hardship is an unexpected tax bill.

A good example of the QPRI exclusion’s application to a loan modification is as follows. Say you owe $250,000 on your mortgage, but your house is only worth $200,000. As part of a loan modification, your mortgage company forgives $50,000 of your balance. Now you owe the same amount as your house is worth. Without the QPRI exclusion, you would get a tax bill for that $50,000 and could owe up to 37% of it to the IRS. With the QPRI exclusion, however, you would not owe anything else.

What are the laws that this comes from? The QPRI exclusion comes from 26 U.S.C. § 108(a)(1)(E), as revived and extended by the Further Consolidated Appropriations Act of 2020, Public Law 116-94, div. Q, Taxpayer Certainty and Disaster Relief Act of 2019, tit. I, subtit. A, § 101 (116th Cong. Dec. 20, 2019), available at https://www.congress.gov/bill/116th-congress/house-bill/1865/text, which became law on December 20, 2019.

If you get a loan modification with principal forgiveness, how do you list it on your tax return? First, this is not accounting advice and you should check with your tax preparer. That said, what you will generally do is attached an IRS Form 982. This form is for “Reduction of Tax Attributes Due to Discharge of Indebtedness.” You will need to check the box on Line 1e, enter the amount canceled on Line 2, and follow the rest of the instructions.

The extension of the QPRI exclusion is a good step to helping homeowners stay in their houses after a loan modification. The last thing anybody needs once they get back on their feet is a tax bill.

Culik Law is a North Carolina consumer protection law firm. We help homeowners solve mortgage problems with everything from loan modifications to anti-foreclosure litigation. If you are struggling, contact us to see if we can help.