Do You Have Cancelled Debt?

Authored By: Community Legal Services of Mid-Florida

What is Cancellation of Debt Income?

Generally, if you are personally liable for a debt, and it is forgiven or satisfied for a lesser amount, you have cancellation of debt income. Cancellation of debt income is taxable. However, there are some ways in which a cancelled debt can be excluded from income.

I received a Form 1099-C. What does this mean?

Lenders are required to send to you (and the IRS) a Form 1099-C, Cancellation of Debt, if the amount forgiven or canceled is $600 or more. The amount of the debt forgiven or cancelled will be shown in box 2. Notify your lender immediately if any of the information shown on Form 1099-C is incorrect.

I received a Form 1099-A. What does this mean?

Lenders are required to send you a Form 1099-A, Acquisition or Abandonment of Secured Property, in cases where there has been an abandonment or foreclosure of property that is security for a debt for which you are the borrower.

What's the difference between a "recourse" and "non-recourse" loan?

“Recourse” means you’re personally liable for the debt. All other debt is “non-recourse”. Generally, there is no cancellation of debt for non-recourse loans. You will receive a 1099-A if there was a foreclosure or property abandonment; you will receive a 1099-S if there was a short sale. There may be cancellation of debt income for recourse loans. You will receive a 1099-C (and sometimes also a 1099-A) if there has been a foreclosure or property abandonment; you will receive a 1099-C and 1099-S if there was a short sale.

When may a cancelled debt be excluded from income?

There are three common situations where you may not have to report cancelled debt as income:

  1. Loan modification or foreclosure of your principal residence during or after 2007. This includes debt used to buy, build, or susbstantially improve your principal residence. The debt must be secured by the home. (Some programs may have expired in 2014. Use the interactive tool below to see if your debt is taxable).
  2. Debts discharged through a bankruptcy.
  3. Insolvency if your total debts exceeded the total value of your assets at the time your debt was cancelled, settled or deemed non-collectible.

You can use the Interactive Tax Assistant available on the IRS website to determine if the cancellation of debt is taxable 

Do I qualify for the insolvency exception?

You are insolvent if your total liabilities or debts, including the cancelled debt, was greater than your total assets at the time your debt was cancelled. Or, put more simply – you owe more than you have.

For example, if your total debts were $8,000 and the value of your total assets at the time was $6,000, you subtract your assets from your debt and you are insolvent in the amount of $2,000. Then:

  1. If you received a 1099-C for $1,000, you may exclude the entire $1,000 from income.
  2. If you received a 1099-C for $2,000, you may exclude the entire $2,000 from income.
  3. If you received a 1099-C for $3,000, you may only exclude $2,000, the extent to which you are insolvent. You would have $1,000 of cancelled debt income.

How much are my assets worth?

Assets include the value of everything you own (including assets that are mortgaged, any pension plans and retirement accounts). Use the fair market value or what you would get if you sold them, rather than what you paid for them or what you think they are worth.

How do I exclude a forgiven debt on my tax return?

The amount of debt forgiven is not reported on your Form 1040. But it must be reported on Form 982 and this form must be attached to your tax return.

 

Updated: April 19, 2017

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