M ortgage debt cancellation occurs when lenders engage in loss-mitigation solutions that either (1) restructure the loan and reduce the principal balance or (2) sell the property, either in advance, or as a result of foreclosure proceedings. 110-142 ) signed into law on December 20, 2007, temporarily excluded qualified COD income. Thus, the act allowed taxpayers who did not qualify for the existing exceptions to exclude COD income. The provision was effective for debt discharged before January 1, 2010. 110-343 ) extended the exclusion of COD income to debt discharged before January 1, 2013. The American Taxpayer Relief Act of 2012 ( P.L. 112-240 ) subsequently extended the exclusion through the end of 2013. Most recently, the Bipartisan Budget Act of 2018 ( P.L. The extension also allowed for debt discharged after 2017 to be excluded from income if the taxpayer had entered into a binding written agreement before January 1, 2018. The rationales for this change are to minimize hardship for households in distress and to ensure that non-tax-related homeowner retention efforts are not thwarted by tax policy. Critics argue that the exclusion could encourage homeowners to be less responsible about fulfilling debt obligations. This income is typically referred to as cancellation of debt (COD) income. As a result of the attribute reduction, the taxpayer may be subject to tax on the excluded COD income in years following the year of discharge—in other words, the tax on the COD income is deferred. Legislative Developments

On December 20, 2007, The Mortgage Forgiveness Debt Relief Act of 2007 ( P.L. The Emergency Economic Stabilization Act of 2008 ( P.L. The Tax Increase Prevention Act of 2014 ( P.L. 113-295 ) extended the exclusion through the end of 2014. The exclusion was extended again through the end of 2016 by Division Q of P.L. 114-113 —the Protecting Americans from Tax Hikes Act (or "PATH" Act). 115-123 ) retroactively extended the exclusion through the end of 2017. If the exclusion on canceled debt income were to expire, improving awareness about the existing exclusions for canceled debt, such as for insolvency or bankruptcy, may be an option to pursue. The first is which tax attributes, if any, should be adjusted to account for excluded canceled mortgage debt income. Basis adjustment results in the taxation of cancelled debt income to the extent that gain from the disposition of the home is taxable; however, the timing of the basis adjustment may result in different tax consequences for taxpayers who lose their home.
A home foreclosure, mortgage default, or mortgage modification can have important tax consequences. As lenders and borrowers work to resolve indebtedness issues, some transactions are resulting in cancellation of debt. Mortgage debt cancellation can occur when lenders restructure loans, reducing principal balances, or sell properties, either in advance, or as a result, of foreclosure proceedings. Historically, if a lender forgives or cancels such debt, tax law has treated it as cancellation of debt (COD) income subject to tax. Exceptions have been available for taxpayers who are insolvent or in bankruptcy, among others—these taxpayers may exclude canceled mortgage debt income under existing law.
The Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110-142) signed into law on December 20, 2007, temporarily excluded qualified COD income. Thus, the act allowed taxpayers who did not qualify for the existing exceptions to exclude COD income. The provision was effective for debt discharged before January 1, 2010. The Emergency Economic Stabilization Act of 2008 (P.L. 110-343) extended the exclusion of COD income to debt discharged before January 1, 2013. The American Taxpayer Relief Act of 2012 (P.L. 112-240) subsequently extended the exclusion through the end of 2013. The Tax Increase Prevention Act of 2014 (P.L. 113-295) extended the exclusion through the end of 2014. The exclusion was extended again through the end of 2016 by Division Q of P.L. 114-113—the Protecting Americans from Tax Hikes Act (or "PATH" Act). Most recently, the Bipartisan Budget Act of 2018 (P.L. 115-123) retroactively extended the exclusion through the end of 2017. The extension also allowed for debt discharged after 2017 to be excluded from income if the taxpayer had entered into a binding written agreement before January 1, 2018.
A rationale for excluding canceled mortgage debt income has focused on minimizing hardship for households in distress. Policymakers have expressed concern that households experiencing hardship and that are in danger of losing their home, presumably as a result of financial distress, should not incur an additional hardship by being taxed on canceled debt income. Some analysts have also drawn a connection between minimizing hardship for individuals and consumer spending; reductions in consumer spending, if significant, can lead to recession.
As efforts to minimize the rate of foreclosure are being made, lenders are, in some cases, renegotiating loans with borrowers to keep them in the home. For some policymakers, the exclusion of canceled mortgage debt income may be a necessary step to ensure that homeowner retention efforts are not thwarted by tax policy.
Opponents of an exclusion for canceled mortgage debt income might argue that the provision would make debt forgiveness more attractive for homeowners, and could encourage homeowners to be less responsible about fulfilling debt obligations.
This report will be updated in the event of significant legislative changes.