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Will I owe taxes after a foreclosure or short sale?

You might. The IRS treats a foreclosure or short sale like selling your home, which can create a gain, and mortgage debt the lender cancels can sometimes count as income. Those are two different tax issues. The federal break for qualifying debt on your main home generally covers debt canceled before January 1, 2026, or canceled under an arrangement made and put in writing before that date. California generally does not give the same break for debt canceled in 2026. Not owing the lender any more does not mean you owe no taxes. Other exceptions may still help, so learn the rules before you choose a path.

By Guillermo Serafin, broker and owner of Serve First Realty. Updated October 2026.

How does the IRS see a foreclosure or short sale?

The IRS treats a foreclosure like a sale. This is true even if you hand the home back to the lender on your own. So there are two separate questions:

  • Did I have a gain or a loss on the "sale"? You compare what you are treated as getting for the home with your basis, which is usually what you paid for it, adjusted over time.
  • Did the lender forgive any debt? If the loan balance was more than the home was worth and the lender let you off the hook for the rest, that forgiven part may be income.

A loss on your own home is not deductible. A gain on your main home may be left out of income, up to 250,000 dollars, or 500,000 dollars for a married couple filing together, if you meet the rules in IRS Publication 523.

Can forgiven mortgage debt count as income?

Yes, in many cases. The IRS calls it canceled debt. If a lender forgives a debt you were personally responsible for, the forgiven amount is usually counted as ordinary income. A lender that forgives 600 dollars or more generally must send you Form 1099-C. Even if no form arrives, the IRS says you must still report canceled debt unless an exception or exclusion applies.

Learn how to read these forms in our guide, Got a 1099-C or 1099-A in the mail?

What changed in 2026?

For years, a special federal rule let many homeowners leave out forgiven debt on their main home. It was called the qualified principal residence indebtedness exclusion. It was limited to 750,000 dollars of debt, or 375,000 dollars if married filing separately.

  • That rule generally covers debt canceled before January 1, 2026.
  • It can also cover debt canceled later under an arrangement that was made and put in writing before January 1, 2026.
  • A bill in Congress, H.R. 917, would bring the rule back. It had not passed as of October 2026. Check IRS Publication 4681 for the latest news.

So for most people, mortgage debt forgiven in 2026 through a foreclosure, short sale, or loan modification may now be taxable, unless another exception fits.

Does California tax forgiven mortgage debt too?

It can. California generally does not give the same break for debt canceled in 2026. That means canceled home loan debt may count as income on your California return, even if the federal rule protects you under a written arrangement made before 2026. Read more in California vs. the IRS.

What exceptions may still help?

  • Insolvency. If your debts were more than the value of everything you owned right before the debt was forgiven, you may leave out some or all of it. See our insolvency worksheet walkthrough.
  • Bankruptcy. Debt canceled in a bankruptcy case is not counted as income.
  • Nonrecourse loans. If you were not personally liable for the loan, giving up the home generally does not create canceled debt income. It may still create a gain. Note that California's anti-deficiency laws, which can stop a lender from collecting the rest of a loan, do not by themselves mean you owe no taxes. See recourse vs. nonrecourse loans.

The IRS and the California Franchise Tax Board both point to the bankruptcy and insolvency exclusions. If you use an exclusion, you usually file IRS Form 982 and may have to reduce certain tax benefits, called tax attributes.

Is a short sale taxed differently from a foreclosure?

The basic tax rules are much the same. One big difference is that California often holds back 3 and one third percent of the price in a short sale for state taxes, while foreclosures and deeds in lieu are exempt. See the short sale withholding surprise and our tax side-by-side.

What should I do now?

  • Before a short sale or deed in lieu, ask the lender in writing whether it will forgive the whole remaining debt.
  • Watch your mail for Forms 1099-A and 1099-C early next year, and check them for mistakes.
  • Save every closing paper, loan statement, and letter about forgiven debt.
  • Use our tax time checklist to gather what you need.
  • Talk to a tax professional. Free help may be available through the IRS Volunteer Income Tax Assistance program at 800-906-9887.

General information, not tax or legal advice. We are not tax professionals. Tax rules change, and every situation is different. Sources: IRS Publication 4681 (2025), IRS Publication 523 (2025), IRS Publication 4731-A (Rev. 10-2024), Instructions for Form 1099-C (Rev. 4-2025), H.R. 917 (119th Congress), California Franchise Tax Board Mortgage Forgiveness Debt Relief page (updated 12/17/2025), and FTB Publication 1016 (Rev. 02-2026).

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