Assessing the Debt
Review any IRS Form 1099-C, Cancellation of Debt you received for the year. If you believe the information on the form is wrong, contact the lender to correct it.
List any debts cancelled during the year for which you didn’t receive a Form 1099-C.
Determine whether the cancellation of debt is taxable income or if it qualifies for an exception or exclusion, which means it is not taxable income.
- Even if a cancelled debt is not taxable income, you may need to complete IRS Form 982 , Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), see below.
Exceptions and Exclusions
There are several EXCEPTIONS to the requirement that you include canceled debt in income. Canceled debt that’s not included in income can be:
- Debt that’s canceled as a gift, bequest, devise, or inheritance
- Certain cancellations of student loans
- A payment of the debt that would have been a deductible expense for the tax year in which it was paid
- For example: your mortgage company cancels the mortgage on your home. Part of the forgiven debt is interest that you could have deducted on your tax return if you’d paid it. The amount of interest forgiven is not included in income
- A qualified purchase price reduction given by a seller
Canceled debt that qualifies for EXCLUSION from gross income is:
- Debt canceled in a Title 11 bankruptcy case
- Debt canceled during insolvency
- Cancellation of qualified farm indebtedness
- Cancellation of qualified real property business indebtedness
- Cancellation of qualified principal home indebtedness
- This exclusion allows taxpayers to exclude up to $2,000,000 ($1,000,000 if married filing separately) of canceled "qualified principal residence indebtedness"
Filing your Taxes
You have to report any taxable amount of a canceled debt as ordinary income on Form 1040 or Form 1040NR tax returns.
To report the amount qualifying for exclusion and other information that may affect your tax liability in future years, you must file IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).
- For example, for cancellation of qualified debt on your principal residence that you exclude from income, you must lower your basis in the residence. This may increase the amount of gain you have if you later sell the residence
Cancellation of Debt is a complex topic — after you review this page, you might want to discuss your particular situation with a tax professional.