Not all forgiven home mortgage debt qualifies for the $2-million exclusion, which is a lesson learned the hard way. She got a home equity line of credit from her bank that was secured by her primary residence.
When she later relinquished the property to the bank in a short sale, the bank issued her a Form 1099-C for the waived debt. She treated the forgiven debt as qualified real property indebtedness and excluded it from her income.
The requirements to qualify for the exclusion, the original debt proceeds must be used to buy, build or substantially improve the residence. And that wasn’t the case here, except for $12,000 that she spent to expand a driveway. The remainder was spent on personal items
Bui, TC Memo. 2019-54