Prior to 2018, homeowners could exclude from gross income the cancellation of a mortgage on their principal residence up to $2 million. This exclusion was limited to a loan to buy, build, or substantially improve a main home. It did not apply to the income from the cancellation of a home equity loan used for purposes other than improving the residence.
For example, Ms. Bui, had a home that was mortgaged to the hilt with various home equity lines of credit. In 2011, she made a short sale to the lender to be relieved of the debt and wanted to exclude all of the debt that was canceled. While the home was her principal residence, not all of the debt qualified for the exclusion.
According to the Tax Court, the original line of credit was for $250,000, of which $12,000 was qualified principal residence indebtedness because it was used to improve the driveway (Mary Bui, TC Memo 2019-54). Thus $238,000 was not qualified principal residence indebtedness, so the homeowner could exclude only $5,299 of the canceled the home equity loan from her income under the qualified principal residence indebtedness exclusion ($243,299 canceled debt minus the $238,000 of the debt that was not qualified principal residence indebtedness).
Note: An additional amount of her debt was excludable because she was insolvent to a certain extent at the time of debt forgiveness.