The phone stopped ringing on a Tuesday in 2009. Within a year it was ringing again, and most of the calls were about the same thing. A homeowner had walked away from a house, or sold it short, or handed the keys back to the bank. The worst part seemed to be over. Then a Form 1099-C showed up in the mailbox.
That form tells the IRS a lender forgave a debt. And under the tax code, forgiven debt can be income.
Think about what that means. The owner lost the house. The owner lost the down payment. And now the owner owes tax on money he never received, on a house he no longer owns.
In 2007, Congress decided that was too much. It passed a law that let most homeowners exclude forgiven mortgage debt on their main home from income. The law was meant to be temporary. It was extended again and again, through the crisis and well past it.
It expired at the end of 2025.
For most home loans forgiven in 2026, that protection is gone. The only exception is debt forgiven under a written agreement with the lender that was in place before January 1, 2026. A bill to bring the exclusion back has been introduced in Congress. It has not moved. California stopped following the federal rule years ago, so California owners can face state tax on forgiven debt even when the federal rule helped.
Here is who is in this spot today.
An owner who bought in 2023, when mortgage rates were climbing toward 8%. A modest down payment. Then life changed. A death. A divorce. A job across the country. The home will not sell for what is owed, and refinancing does not help, because the rate today is not low enough to make the payment work.
This is not 2009. Most homeowners today have low rates and real equity. But this owner is not most homeowners, and for this owner the 2009 problem is very real.
Here is the math.
A home worth $400,000. A loan of $500,000. The lender takes the home and forgives the $100,000 difference. If the owner was personally liable on the loan, that $100,000 can be ordinary income. In the 24% bracket, that is about $24,000 of federal tax. Due in April. On money the owner never saw.
Personal liability makes all the difference. When the owner is personally liable, a foreclosure is split in two: a sale of the home at its value, and forgiveness of everything above it. When the owner is not personally liable, the tax code treats the foreclosure as a sale for the full loan balance. There may be no forgiven-debt income at all. Which kind of loan you have depends on your state and on the papers you signed.
There are still ways out.
If the owner is insolvent, meaning debts are greater than assets at the moment the debt is forgiven, forgiven debt can be excluded up to the amount of the insolvency. Bankruptcy has its own exclusion. And the structure of the deal with the lender matters. A short sale, a foreclosure, and a deed in lieu of foreclosure can each produce a different answer on the tax return.
None of these is free. Each one comes with rules, and each one reduces something else, like basis or other tax benefits, that the owner may need later. And no form in the mailbox does not mean no income. Forgiven debt is reportable whether a 1099-C arrives or not.
The owners who came through 2009 in the best shape had one thing in common. They asked the tax question before they signed the paperwork, not after.
The lender negotiates the debt. Somebody has to negotiate the tax.
Before you hand back the keys, sign a short sale, or accept a deed in lieu, talk to a tax planner. This is general information, not tax advice for your situation, and the right answer depends on your loan, your state, and your finances.
Forgiven is not forgotten.