Debt includes any incurred, whether personally liable or only to the limits of the property that secures the debt. Debts secured by property that are canceled, either in whole or in part, are typically the result of foreclosure, repossession, property abandonment, loan modification or voluntary surrender of the property.
You will receive a Form 1099-C, Cancellation of Debt, when any of your debt is canceled, forgiven or discharged. This form will state the canceled amount in gross income, provided no exclusions or exceptions apply. Always be sure to verify your specific situation with your creditor, especially if you receive the form but debt collection attempts are still occurring.
You are required to report any portion of cancelled debts that are taxable, in which you may be held liable for. You have to report all taxable amount regardless of whether or not you receive a Form 1099-C. You can use Form 1040 to report these amounts.
It’s important to note that if your creditor takes your secured property as satisfaction of your debt, the IRS considers that property sold, in which cases you may be subject to taxable gains or losses. You should be aware of different tax circumstances that apply when property is sold for capital gains, as this issue is separate from the canceled debt taxation.
Some canceled debt may be an exception to being included in your gross income provided it meets the following requirements:
- Any amount excluded by law, including gifts, bequests, devises, or inheritances
- Certain qualifying student loan debt
- Debt that is deductible if paid as cash to a taxpayer
- Any qualifying purchase price reduction offered by the seller
- Reduction of the principle balance of a mortgage through the Home Affordable Modification Program.
Canceled debt that is excluded from your gross income:
- Title 11 bankruptcy cancellation
- Insolvency cancellation
- Qualified farm debt cancellation
- Cancellation of real property business that qualifies
- Cancellation of qualified principle residence debt.
Homeowners who fell victim to the foreclosure crisis can benefit from the tax relief provided for canceled debt exclusion on principal residences. This exclusion can offer those taxpayers affected an exclusion of up to $2,000,000 ($1,000,000 if married filing separately) of canceled qualified principal residence indebtedness.
Typically, exclusion of canceled debt requires you to reduce the amount of tax attributes, such as losses, credits and basis of assets. You can file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to determine the qualifying exclusion amount. Principal residence debt cancellation only requires a reduction of the base amount of the principal residence. Review all Form 1099-C for accuracy upon receipt. In the event the information is incorrect, contact your lender for corrections.
