Did you have debt that was cancelled during the tax year? If so, you may have you to include the cancelled debt amount in income for tax purposes. The lender is usually required to report the amount of the cancelled debt to you and the IRS on Form 1099-C, Cancellation of Debt.
Reporting cancelled debt as income can result in a high and unexpected tax liability for many taxpayers. However, there are certain exceptions to the rule. By understanding the exceptions and determining if your situation qualifies for one of these exceptions, you may be able to significantly reduce your tax liability.
Some of the more common situations where cancellation of debt income may not be taxable include:
- Qualified principal residence indebtedness: If your principal residence has been foreclosed on or you’ve sold your principal residence via a short sale, the Mortgage Forgiveness Debt Relief Act may allow most homeowners to exclude certain cancelled debt.
- Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
- Insolvency: If you are insolvent when the debt is cancelled, the cancelled debt may not be taxable. You are considered insolvent if your debts are more than the value of your assets.
- Non-recourse loans: A loan where the lender’s only recourse in case of default is to repossess the property that was financed or used as collateral.
The amount of cancelled debt income and cancelled debt excluded from income must be reported on IRS Form 982.
For more information about Cancellation of Debt Income, review IRS Publication 4681, Cancelled Debts, Foreclosures, Repossessions and Abandonments or discuss your situation with your Tax Professional and/or see Liberty Tax Service's Tax Tips.
Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.