Forgiveness of Debt
Brad Hess
Partnerships for Real Estate Investing
¶1040.04.F. Principal Residence Indebtedness Exclusion
1. General Rule
In December 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act in order to provide another
exclusion from the discharge of indebtedness rules. Generally, income from discharge of indebtedness is
excluded from gross income if the discharge is by reason (in whole or in part) of qualified principal residence
indebtedness. 273.1
In order for this exclusion to apply, the debt must be discharged on or after January 1,
2007, and before January 1, 2013. 273.2 For purposes of the exclusion, the term "qualified principal residence
indebtedness” means acquisition indebtedness within the meaning of §163(h)(3)(B), except the limitation is
raised to $2,000,000 (or $1,000,000 in the case of married individuals filing separate returns), with respect to
the taxpayer's principal residence. 273.3 Further, the term “principal residence” has the same meaning as
under §121. 273.4
273.1 §108(a)(1)(E), as added by 2007 MFDRA, P.L. 110-142, §2(a), and extended by the 2008
Emergency Economic Stimulus Act, P.L. 110-343, Div. A, §303.
273.2 §108(a)(1)(E), as added by 2007 MFDRA, P.L. 110–142, §2(a), (d), and extended by
2008 Emergency Economic Stabilization Act, Div. A, §303.
273.3 §108(h)(2), as added by 2007 MFDRA, P.L. 110–142, §2(b).
273.4 §108(h)(5), as added by 2007 MFDRA, P.L. 110–142, §2(b).
There is an exception to the exclusion where the loan is discharged on account of services performed for the
lender or any other factor not directly related to a decline in the value of the residence or the financial
condition of the taxpayer. 273.5
In the case where only a portion of a loan is considered “qualified principal
residence indebtedness,” the exclusion applies only to so much of the amount discharged as exceeds the
amount of the loan (as determined immediately before such discharge) which is not qualified principal
residence indebtedness. 273.6
273.5 §108(h)(3), as added by 2007 MFDRA, P.L. 110–142, §2(b).
273.6 §108(h)(4), as added by 2007 MFDRA, P.L. 110–142, §2(b).
2. Coordination of Statutory Exclusions
In the case of an insolvent taxpayer not in a Title 11 case, the principal residence indebtedness exclusion
applies unless the taxpayer elects to have the current insolvency exception under §108(a)(1)(B) apply. 273.7
273.7 §108(a)(2)(C), as added by 2007 MFDRA, P.L. 110–142, §2(c)(2).
3. Basis Reduction
Any amounts excluded as a result of the principal residence indebtedness exclusion must be applied to reduce
the basis of taxpayer's principal residence (but not below zero). 273.8
273.8 §108(h)(1), as added by 2007 MFDRA, P.L. 110–142, §2(b).