Is Canceled Debt Taxable?

shutterstock_157769453

Is Canceled Debt Taxable?

Generally, debt that is forgiven or canceled by a lender is considered taxable income by the IRS and must be included as income on your tax return. Examples include a debt for which you are personally liable such as mortgage debt, credit card debt, and in some instances, student loan debt.

When that debt is forgiven, negotiated down (when you pay less than you owe), or canceled you will receive Form 1099-CCancellation of Debt, from your financial institution or credit union. Form 1099-C shows the amount of canceled or forgiven debt that was reported to the IRS. If you and another person were jointly and severally liable for a canceled debt, each of you may get a Form 1099-C showing the entire amount of the canceled debt. Give the office a call if you have any questions regarding joint liability of canceled debt.

Creditors who forgive $600 or more of debt are required to issue this form. If you receive a Form 1099-C and the information is incorrect, contact the lender to make corrections.

If you receive a Form 1099-C, don’t ignore it. You may not have to report that entire amount shown on Form 1099-C as income. The amount, if any, you must report depends on all the facts and circumstances. Generally, however, unless you meet one of the exceptions or exclusions discussed below, you must report any taxable canceled debt reported on Form 1099-C as ordinary income on:

  • Form 1040 or Form 1040NR, if the debt is a nonbusiness debt;
  • Schedule C or Schedule C-EZ (Form 1040), if the debt is related to a nonfarm sole proprietorship;
  • Schedule E (Form 1040), if the debt is related to non-farm rental of real property;
  • Form 4835, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or
  • Schedule F (Form 1040), if the debt is farm debt and you are a farmer.

Exceptions and Exclusions

If you’ve had debt forgiven or canceled this year and receive a Form 1099-C, you might qualify for an exception or exclusion. If your canceled debt meets the requirements for an exception or exclusion, then you don’t need to report your canceled debt on your tax return. Under the federal tax code, there are five exceptions and four exclusions for tax year 2015. Here are the five most commonly used:

Note: The Mortgage Debt Relief Act of 2007, which applied to debt forgiven in calendar years 2007 through 2014, allowed taxpayers to exclude income from the discharge of debt on their principal residence. Up to $2 million of forgiven debt was eligible for this exclusion ($1 million if married filing separately) and debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, also qualified for the relief. As of this writing, Congress has yet to reauthorize the Act for calendar year 2015.

1. Amounts specifically excluded from income by law such as gifts, bequests, devises or inheritances

In most cases, you do not have income from canceled debt if the debt is canceled as a gift, bequest, devise, or inheritance. For example, if an acquaintance or family member loaned you money (and for whom you signed a promissory note) died and relieved you of the obligation to pay back the loan in his or her will, this exception would apply.

2. Cancellation of certain qualified student loans

Certain student loans provide that all or part of the debt incurred to attend a qualified educational institution will be canceled if the person who received the loan works for a certain period of time in certain professions for any of a broad class of employers. If your student loan is canceled as the result of this type of provision, the cancellation of this debt is not included in your gross income.

3. Canceled debt, that if it were paid by a cash basis taxpayer, would be deductible

If you use the cash method of accounting, then you do not realize income from the cancellation of debt if the payment of the debt would have been a deductible expense.

For example, in 2014, you obtain accounting services for your farm using credit. In 2015, due to financial troubles you are not able to pay off your farm debts and your accountant forgives a portion of the amount you owe for her services. If you use the cash method of accounting you do not include the canceled debt as income on your tax return because payment of the debt would have been deductible as a business expense.

4. Debt canceled in a Title 11 bankruptcy case

Debt canceled in a Title 11 bankruptcy case is not included in your income.

5. Debt canceled during insolvency

Do not include a canceled debt as income if you were insolvent immediately before the cancellation. In the eyes of the IRS, you would be considered insolvent if the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation.

For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account).

Here’s an example. Let’s say you owe $25,000 in credit card debt, which you are able to negotiate down to $5,000. You have no other debts and your assets are worth $15,000. Your canceled debt is $20,000. Your insolvency amount is $10,000. Because you are insolvent at the time of the cancellation, you are only required to report the $10,000 on your tax return.

If you exclude canceled debt from income under one of the exclusions listed above, you must reduce certain tax attributes (certain credits, losses, basis of assets, etc.), within limits, by the amount excluded. If this is the case, then you must file Form 982Reduction 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.

Exceptions do not require you to reduce your tax attributes.

Questions?

Don’t hesitate to call if you have any questions about whether you qualify for debt cancellation relief.

Mortgage Debt Forgiveness: 10 Key Points

IRS Tax Tip 2012-39

 Canceled debt is normally taxable to you, but there are exceptions. One of those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

The IRS would like you to know these 10 facts about Mortgage Debt Forgiveness:

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit www.irs.gov. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, is also an excellent resource.

You can also use the Interactive Tax Assistant available on the IRS website to determine if your cancelled debt is taxable. The ITA takes you through a series of questions and provides you with responses to tax law questions.

Finally, you may obtain copies of IRS publications and forms either by downloading them from www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

 

For more information: www.onts9.com

 

Mortgage Debt Forgiveness: 10 Key Points

Issue Number:    IRS Tax Tip 2012-39

 

Canceled debt is normally taxable to you, but there are exceptions. One of those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

The IRS would like you to know these 10 facts about Mortgage Debt Forgiveness:

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit www.irs.gov. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, is also an excellent resource.

You can also use the Interactive Tax Assistant available on the IRS website to determine if your cancelled debt is taxable. The ITA takes you through a series of questions and provides you with responses to tax law questions.

Finally, you may obtain copies of IRS publications and forms either by downloading them from www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

For more information: www.onts9.com