Forgiven Debt in 2026: Insolvency, Bankruptcy, Form 982, and the Exclusions That Changed

When a lender forgives a debt, the general rule is simple: the forgiven amount is income. A $30,000 credit card settlement for $9,000 can mean $21,000 of taxable income, and the bill arrives the following spring, often for someone who settled precisely because money was tight.

The good news is that the tax code contains several exclusions, and many people who receive a Form 1099-C qualify for at least one of them. The bad news is that the exclusions are not automatic. You have to claim them, document them, and accept some trade-offs that show up in later years. And for 2026, two popular exclusions have changed. Here is how the rules work now.

First, Confirm There Is Income to Exclude

Before looking for an exclusion, make sure the forgiven amount is really income. Several situations produce no cancellation of debt income at all:

• Nonrecourse foreclosures. When the lender's only remedy is the property, a foreclosure is treated as a sale for the full debt amount. You may have gain or loss, but not cancellation of debt income.
• Debt that would have been deductible. If paying the debt would have produced a deduction, such as certain business expenses for a cash-method taxpayer, forgiveness generally is not income.
• Purchase price reductions. When a seller who financed your purchase reduces what you owe, it is generally treated as a reduction in price, not income, as long as you are not bankrupt or insolvent.
• Gifts. A relative who forgives a loan out of generosity is making a gift, not creating income.
• Errors on the form itself. A Form 1099-C can report the wrong amount, the wrong year, or a debt that was never actually discharged.

For a recourse debt where the lender takes the property, the transaction splits in two: a sale at fair market value and cancellation income for any debt above that value. That split matters because the exclusions below apply only to the cancellation part.

The Main Exclusions in 2026

Section 108(a) lists the exclusions. The IRS explains each of them in Publication 4681.

• Bankruptcy. Debt discharged in a Title 11 bankruptcy case is fully excluded. This exclusion takes priority over the others.
• Insolvency. If, just before the discharge, everything you owed was more than everything you owned (measured at fair market value), the shortfall is your insolvency, and you can exclude forgiven debt up to that shortfall.
• Qualified farm debt. Certain debt of qualified farmers owed to qualified lenders can be excluded, subject to limits.
• Qualified real property business debt. Taxpayers other than C corporations can elect to exclude certain debt secured by business real property, limited by the property's basis and value.

What Changed for 2026

Mortgage forgiveness on a main home. The exclusion for qualified principal residence indebtedness expired for discharges after December 31, 2025. The Joint Committee on Taxation confirmed the expiration in its April 2026 list of expiring provisions. There is a narrow transition rule for discharges under an arrangement entered into and evidenced in writing before January 1, 2026. Otherwise, homeowners with a 2026 short sale, loan modification, or foreclosure deficiency will need to rely on insolvency, bankruptcy, or a no-income argument.

Student loans. The broad exclusion that covered most student loan forgiveness from 2021 through 2025 also expired. Congress, in the One Big Beautiful Bill Act, made permanent a narrower exclusion for student loans discharged because of the borrower's death or total and permanent disability, with a requirement to include the borrower's Social Security number on the return. Forgiveness under certain programs, such as Public Service Loan Forgiveness, continues to be excluded under separate rules. Other forgiveness, including some income-driven repayment discharges, may now be taxable.

Getting Insolvency Right

Insolvency is the exclusion most people use, and also the easiest to miscalculate. Some practical tips:

• Use the moment just before the discharge. The test is a snapshot, not an annual average. If you settled several debts on different dates, each may need its own calculation.
• Count every asset at fair market value. That includes retirement accounts, home equity, vehicles, household goods, and even assets that creditors cannot reach. The Tax Court held in Carlson v. Commissioner, 116 T.C. 87 (2001), that exempt assets count.
• Count every liability, including the debt being canceled, credit cards, medical bills, tax debts, mortgages, car loans, and personal guarantees where you are likely to pay.
• Use the IRS worksheet. Publication 4681 includes an insolvency worksheet. Fill it in and keep it with your supporting statements.
• Remember the cap. If you were insolvent by $12,000 and the canceled debt was $20,000, only $12,000 is excluded. The remaining $8,000 is taxable.

Claiming the Exclusion on Form 982

Exclusions are claimed on Form 982, attached to your return. Part I has a separate box for each exclusion: line 1a for bankruptcy, 1b for insolvency, 1c for qualified farm debt, 1d for qualified real property business debt, and 1e for qualified principal residence debt. Line 2 shows the amount excluded. Without Form 982, the IRS matching system sees a 1099-C and no income, and a notice usually follows.

The Trade-Off: Reducing Tax Attributes

An exclusion is often a deferral rather than a permanent break. When you exclude income under the bankruptcy, insolvency, or farm debt rules, you generally must reduce certain tax attributes by the excluded amount, in this order:

• net operating losses,
• general business credit carryovers,
• minimum tax credit,
• capital loss carryovers,
• basis of property,
• passive activity loss and credit carryovers, and
• foreign tax credit carryovers.

You can elect on Form 982 to reduce the basis of depreciable property first, which can be valuable if you expect to have losses or credits you would rather keep. For individuals with few attributes, the reduction often has little practical cost. For business owners and real estate investors, it can shape future depreciation and gain, so it is worth modeling before filing.

Practical Tips

• Gather documents early. Statements for every account and debt as of the discharge date are much easier to get now than two years from now.
• Value assets honestly. Use realistic sale values, not purchase prices or optimistic estimates. An overstated liability or understated asset can undo the exclusion in an audit.
• Handle multiple forms carefully. If you received several 1099-Cs, confirm whether they relate to the same debt and whether each discharge needs its own insolvency calculation.
• Coordinate with your spouse. Insolvency is generally tested separately for each spouse, even on a joint return, based on each person's own assets and liabilities.
• Consider a disclosure. Where the position depends on judgment, such as a disputed value, a short explanation can help.

A Worked Example

Suppose a hypothetical taxpayer settles a $26,000 personal loan for $6,000 in March 2026, and the lender issues a 1099-C for $20,000. Immediately before the settlement, she has $7,000 in checking, a car worth $11,000, household goods worth $3,000, and a 401(k) worth $34,000, for total assets of $55,000. Her liabilities are the $26,000 loan, a $24,000 car loan, $9,000 in credit cards, and $10,000 in medical bills, for a total of $69,000. She is insolvent by $14,000. She files Form 982, checks line 1b, and excludes $14,000. The other $6,000 of canceled debt is taxable. Because she has no carryovers, the attribute reduction falls mainly on the basis of her property, which has little practical effect for her.

Key Takeaways

• Canceled debt is usually income, but first confirm it is not a nonrecourse foreclosure, purchase price reduction, gift, or reporting error.
• Bankruptcy and insolvency are the most common exclusions. Insolvency is a snapshot taken just before the discharge and counts retirement accounts and exempt assets.
• The principal residence mortgage exclusion expired after 2025, except for certain written arrangements made before 2026.
• Broad student loan forgiveness relief also ended after 2025. The death and disability exclusion is now permanent.
• Claim exclusions on Form 982, and plan for the reduction of tax attributes that may follow.

If you settled a debt, went through a short sale, or received a Form 1099-C this year, schedule a consultation with SMB CPA Group before you file. You can also contact us, explore our solutions, or review our pricing. Real estate investors may also want to read about our work with real estate professionals.

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