Any debt that has been canceled can be considered taxable on your income tax return. You would normally receive a Form 1099-C, Cancellation of Debt, showing the amount that has been forgiven by the lender.
When the money was borrowed you did not have to include the amount you received in income because it was intended that you would repay this amount to your creditor. When that loan is no longer due (forgiven), the amount you received as income originally is reportable as taxable because you no longer have an obligation to repay the lender.
In what situations Debt Cancellation or Forgiveness may not be taxable…
- You filed Bankruptcy: any debt that was forgiven by a lender specifically because you filed bankruptcy is excludable from income on your tax return.
- You were Insolvent: if at the time of your debt forgiveness you owed out more money than you were in possession of, you were insolvent (the IRS offers a worksheet to help you calculate insolvency). You are allowed to exclude debt forgiveness up to the amount that your debt was more than your assets.
- You owned a Farm: if your debt was directly related to operating a farm and more than 50% of your income for the last three years was from farming, your debt forgiveness is excludable.
- You had a Non-Recourse Loan: qualified real property business indebtedness can be excluded from taxable income. This is a loan taken out by using a business asset, which is real property, (such as a retail store) as collateral where the loan is also then used in the trade or business.
- You owned a Qualified Principle Residence: If you had debt forgiven on a loan that was used to purchase your main place of residence, you can exclude up to $2 million of canceled debt from taxable income.
These are all circumstances in which you may be able to lower your taxable income caused by debt forgiveness and you would most likely be required to file a Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. If you have had debt forgiven and think you may qualify for one of these situations listed above, contact your accountant’s office today!