Cancellation of Debt And Home Foreclosures
Cancellation of debt is a situation in which you borrow money from a lender and the debt you owe is canceled or forgiven. However, you may owe taxes on the forgiven debt.
A federal government agency or lender who cancels or forgives a debt of $600 or more is required to file IRS Form 1099-C, Cancellation of Debt, which shows amounts and other information relating to the debt.
Is cancellation of debt income always taxable?
Cancellation of debt income is not always taxable. The most common situations when cancellation of debt income is not taxable include:
- Qualified principal residence indebtedness – This means that often, debt that is forgiven in relation to or as part of a mortgage being restructured or foreclosed on, is not considered taxable income. Your mortgage is the loan you took out with a bank or mortgage broker to buy, build or substantially improve your primary residence. This exception is the most common type of exception and applies to most homeowners.
- Bankruptcy – Debts forgiven due to Title 11 bankruptcy are not considered taxable income.
- Insolvency – A taxpayer is insolvent when a taxpayer’s total debt exceeds his or her total assets. If your total debt exceeds your assets when the debt is cancelled, some or all of the cancelled debt may not be taxable.
Farm debts may not be considered taxable income if:
- If debt was accrued directly due to operation of a farm;
- More than half your income from the past three years was from farming;
- And the debt was owed to a person or agency regularly engaged in lending.
- Non-recourse loans – A non-recourse loan does not allow the lender to pursue anything other than property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
If all or part of the canceled debt qualifies to be excluded under one of the exclusions listed above, the amount excluded from income must be reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), and attached to your tax return. The remaining canceled debt, if any, must be included as income on your tax return.
Where do I report taxable canceled debt?
- Personal debt – Report the amount of the canceled debt on Form 1040, line 21.
- Business debt – Report the amount on Schedule C (Form 1040) or Schedule C-EZ (Form 1040)
- Farm debt – Report the amount on Schedule F (Form 1040), Profit or Loss from Farming