Cancelled Debt – Is It Taxable or Not?

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If you borrow money and are legally obligated to repay a fixed or determinable amount at a future date, you have a debt.

You may be personally liable for a debt or may own a property that’s subject to a debt.

If your debt is forgiven or discharged for less that the full amount you owe, the debt is considered cancelled in the amount that you don’t have to pay.

The law provides several exceptions, however, in which the amount you don’t have to pay isn’t cancelled debt. These exceptions will be discussed later.

Cancellation of a debt may occur if the creditor can’t collect, or gives up on collecting, the amount you’re obligated to pay. If you own property subject to a debt, cancellation of the debt also may occur because of a foreclosure, a repossession, a voluntary transfer of the property to the lender, abandonment of the property, or a mortgage modification.

In general, if you have cancellation of debt income because your debt is cancelled, forgiven, or discharged for less that the amount you must pay, the amount of the cancelled debt is taxable and you must report the cancelled debt on your tax return for the year the cancellation occurs.

The cancelled debt isn’t taxable, however, if the law specifically allows you to exclude it from gross income. These specific exclusions will be discussed later.

After a debt is cancelled, the creditor may send you a Form 1099-C.pdf, Cancellation of Debt, showing the amount of cancellation of debt and the date of cancellation, among other things.

If you received a Form 1099-C showing incorrect information, contact the creditor to make corrections. For example, if the creditor is continuing to try to collect the debt after sending you a Form 1099-C, the creditor may not have cancelled the debt and, as a result, you may not have income from a cancelled debt.

You should verify with the creditor your specific situation.

Your responsibility to report the taxable amount of cancelled debt as income on your tax return for the year when the cancellation occurs doesn’t change whether or not you receive a correct Form 1099-C.

In general, you must report any taxable amount of a cancelled debt as ordinary income from the cancellation of debt on Form 1040.pdf, U.S. individual Income Tax Return, or Form 1040NR.pdf, U.S. Nonresident Alien Income Tax Return, as “other income” on line 21 if the debt is a non-business debt, or an applicable schedule if the debt is a business debt.

Caution:

If property secured your debt and the creditor takes that property in full or partial satisfaction of your debt, you’re treated as having sold that property. Your amount realized and ordinary income depend on whether you are personally liable for the debt (recourse debt) or not personally liable for the debt (non-recourse debt).

If your property was subject to a recourse debt, your amount realized is the fair market value (FMV) of the property. Your ordinary income from the cancellation of the debt is the amount of the debt in excess of the FMV of the property that the lender forgives. You must include this cancellation of debt in your income unless an exception or exclusion, discussed below, applies.

If your property was subject to a non-recourse debt, your amount realized is the entire amount of the non-recourse debt plus the amount of cash and the FMV of any property you received.

You will not have ordinary income from the cancellation of the debt. See Publication 4681.pdf, Cancelled Debts, Foreclosures, Repossessions, and abandonment (for individuals). See also Publication 544, Sales and Other Dispositions of Assets, and Publication 523, Selling Your Home, for detailed information on reporting gain or loss from repossession, foreclosure, or abandonment of property.
Amounts that meet the requirements for any of the following exceptions aren’t cancellation of debt income.

EXCEPTIONS to Cancellation of Debt Income:

1. Amounts cancelled as gifts, , devises, or inheritances
2. Certain qualified student loans cancelled under the loan provisions that the loans would be cancelled if you work for a certain period of time in certain professions for a broad class of employers
3. Certain other education loan repayment or loan forgiveness programs to help provide health services in certain areas.
4. Amounts of cancelled debt that would be deductible if you, as a cash basis taxpayer, paid it
5. A qualified purchase price reduction given by the seller of property to the buyer
6. Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program

Amounts that meet the requirements for any of the following exclusions aren’t included in income, even though they’re cancellation of debt income.

EXCLUSIONS from Gross Income:

1. Debt cancelled in a Title 11 bankruptcy case
2. Debt cancelled during insolvency
3. Cancellation of qualified farm indebtedness
4. Cancellation of qualified real property business indebtedness
5. Cancellation of qualified principal residence indebtedness that is discharged subject to an arrangement that is entered into and evidenced in writing before January 1, 2018.

Generally, if you exclude cancelled debt from income under one of the exclusions listed above, you must reduce certain tax attributes (certain credits and carryovers, losses and carryovers, basis of assets, etc.) (but not below zero) by the amount excluded.

You must attach to your tax return a Form 982.pdf, 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 those tax attributes.

For cancellation of qualified principal residence indebtedness that you exclude from income, you must only reduce your basis in your principal residence.