A lender will, on occasion, forgive some portion of a borrower's debt, or reduce the principal balance. The general tax rule that applies to any debt forgiveness is that the amount forgiven is treated as taxable income to the borrower. Some exceptions to this rule are available, but, until 2007, when a lender forgave some portion of a mortgage debt for which the borrower was personally liable (such as in so-called "short sales," foreclosures and "workouts"), the borrower was required to pay tax on the debt forgiven.

A law enacted in 2007 provided temporary relief to troubled borrowers when some portion of mortgage debt is forgiven and the mortgage covers the borrower's principal residence. That relief has expired and been extended several times. That relief has expired and been extended several times. The latest extension, enacted in December 2020, provides relief for debt forgiven from January 1, 2021 through December 31, 2025.

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