Generally speaking, if you’ve had debt forgiven by a creditor, you must report the amount that was forgiven as taxable income. (In other words, you must add it to your taxable income, which will usually increase the amount of taxes you must pay.) But, if you’ve had mortgage debt forgiven in calendar years 2007 through 2012, you may be able to take advantage of The Mortgage Debt Relief Act of 2007.
If you have canceled (forgiven) debt, it should have been reported to you on Form 1099-C. The Mortgage Debt Relief Act may allow you to exclude up to $2 million of the forgiven mortgage debt (if you file as married filing jointly) and up to $1 million (if married filing separately) from your income.
What qualifies?
Not all mortgage debt forgiveness will qualify to be excluded. Generally speaking though, the following is allowed according to the IRS:
You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.
To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
What if I refinanced to pay off debt?
One of the bigger dangers of refinancing your house in order to “pay off” other debt is that you won’t actually change your habits, but will instead make your debt situation worse. A common example of this is refinancing your house in order to “pay off” credit card debt. (There’s a reason I keep putting “pay off” in quotes like that: you’re not actually paying off the debt. You’re just rearranging it.)
But, to get back to the question, if you refinanced your house in order to pay off other debt or to do something like take a dream trip, buy new furniture, etc., and then receive mortgage debt forgiveness, that debt does not qualify for the exclusion. So, you’d still need to report it as an addition to your income.
If you’re not sure…
If you’re not sure whether your mortgage debt forgiveness qualifies, check with a tax professional, or review Publication 4681 and the questions and answers found on this page. You can also use the IRS’ interactive assistant to get an idea of whether or not your mortgage debt forgiveness qualifies.
I'm Jackie Beck, personal finance writer and creator of 
That’s the one thing I want to change desperately… My mortgage situation. I feel like I keep going in circles with them. That might be because they are taking me for a ride.
What’s going on with your mortgage, if you don’t mind sharing?
What if I just refinance to lower APR on it? Do I need to pay increased taxes?
No, refinancing isn’t debt forgiveness.
I would love to have my mortgage “forgiven” ! ;) Until then, we will keep making out monthly payments…
Hah, not me, since that usually means you lost the house in foreclosure or a short sale…
I think it’s great that there are options for people considering the horrid state of some real estate markets. I’m lucky to have just gone through the refi process successfully for no other reason than locking in a lower rate. I’ll be saving almost $350/month now!
That’s got to be a much lower rate then!
I’m glad you put the bunny ears around “paying off” – because you’re right, it’s merely rearranging your finances. That’s why I don’t understand the people who are constantly refinancing – and paying closing costs. They’re only accruing MORE debt!
Sometimes refinancing a mortgage makes a ton of sense (such as to reduce the interest rate on it, especially if you’re also shortening the term). But refinancing for the purposes of rearranging debt…not so much.