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Debt cancellation is a process through which a creditor chooses to dismiss or cancel a debt owed by a creditor. Depending on the circumstances, this type of cancellation of debt may apply to the entire outstanding balance, or only to a portion.
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The provisions for debt cancellation may vary, but are usually put in place when a lender or creditor agrees to do business with a customer. One of the more common approaches is the creation of what is known as a debt cancellation contract.
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- A debt includes any indebtedness whether you are personally liable or liable only to the extent of the property securing the debt. Cancellation of all or part of a debt that is secured by property may occur because of a foreclosure, a repossession, a voluntary return of the property to the lender, abandonment of the property, or a principal residence loan modification.
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In general, if you are liable for a debt that is canceled, forgiven, or discharged, you will receive a Form 1099-C, Cancellation of Debt, and must include the canceled amount in gross income unless you meet an exclusion or exception.
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Credit card debt, home mortgages, business debt, bank loans, student loans and other personal loans are reported as income if canceled.
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| If you receive a Form 1099-C but the creditor is continuing to try to collect the debt, the creditor may not have canceled the debt. You should verify with the creditor your specific situation; you might not have cancellation of debt or taxable income. |
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| You must report any taxable amount of a canceled debt for which you are personally liable, as ordinary income from the cancellation of debt, on Form 1040 or Form 1040NR and associated schedules, as advised in Publication 4681 (PDF), Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). You must report the taxable amount of a taxable canceled debt whether or not you receive a Form 1099-C. |
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| If your debt is secured by property and that property is taken by the lender in full or partial satisfaction of your debt, you are treated as having sold that property and may have a taxable gain or loss. The gain or loss on such a deemed sale of your property is an issue separate from whether any cancellation of debt income associated with that same property is includable in gross income. |
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| Canceled debts that meet the requirements for any of the following exceptions or exclusions are not taxable. |
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Debt Cancellations or Reductions that Qualify for EXCEPTION to Inclusion in Gross Income are the following:
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| Canceled Debt that Qualifies for EXCLUSION from Gross Income includes the following: |
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| The exclusion for "qualified principal residence indebtedness" provided tax relief on canceled debt for many homeowners involved in the mortgage foreclosure crisis currently affecting much of the United States. The exclusion allows taxpayers to exclude up to $2,000,000 ($1,000,000 if married filing separately) of canceled "qualified principal residence indebtedness." The exclusion for cancellation of qualified principal residence indebtedness expired December 31, 2013. You may claim it on your tax year 2013 tax return if you qualify. Under current law, the exclusion is not available for tax years after 2013. |
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Generally, if you exclude canceled debt from income under one of the exclusions listed above, you must reduce your positive tax attributes (certain credits, losses, basis of assets, etc.), within limits, by the amount excluded.
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| You must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to report the amount qualifying for exclusion and any corresponding reduction of certain tax attributes. For cancellation of qualified principal residence indebtedness that you exclude from income, you must only reduce your basis in your principal residence. |
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| If you received a Form 1099-C and the information is incorrect, contact the lender to make corrections. |
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Perhaps even more important, contact a tax professional to make sure you comply with all IRS requirements and include in your income only what is necessary and nothing else.
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