Cancellation of Debt

If you owe a debt to someone who cancels or forgives all or some of the debt, you are usually treated as having received income for income tax purposes, and you may have to pay tax on this income.

A debt includes debt that you’re fully liable for like credit card debt and debt that you’re liable for only up to the value of property securing the debt such as a mortgage debt secured by a home in some states. A debt secured by property may be considered cancelled because of a foreclosure, a repossession, you voluntarily returning the property to the lender, you abandoned the property, or because of a loan modification.

The amount of the cancellation of debt is included in your income unless an exception or exclusion applies. This concept is explained in detail in What should I do?, below.

In general, if you’re liable for a debt that’s canceled, forgiven, or discharged, you’ll receive a IRS Form 1099-C, Cancellation of Debt, from the lender or the person who forgave the debt.

  • You may receive a IRS Form 1099-C while the creditor is still trying to collect the debt. If so, the creditor may not have canceled it. Contact the creditor and verify your situation.
  • You must report the canceled debt (one that doesn’t qualify for an exception or exclusion from gross income) on your income tax return whether or not you receive a IRS Form 1099-C.

Cancellation of Debt is a complex topic — after you review this page, you might want to discuss your particular situation with a tax professional.

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 IRS 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 canceled 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, and
    • 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, and
  • 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 IRS Form 1040 or IRS 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.

Different types of debt may have different tax treatments. For example, if your debt is secured by property and the lender takes the property to fully or partially satisfy your debt, you are treated as having “sold” that property and may have a taxable gain or loss. The gain or loss on such a “sale” is separate from any cancellation of debt income that you need to include on your return.

Not reporting the taxable amount of a cancelled debt may lead to an audit, where the IRS may charge additional tax, interest, and penalties.

I filed for bankruptcy. What happens to debt amounts then? See Publication 908, Bankruptcy Tax Guide, for information on taxable items under bankruptcy. Generally, if debt is canceled under the U.S. bankruptcy laws it is excludable from taxable income, but some exceptions and requirements apply.

Have a different tax issue?  Browse common issues and situations at Get Help.

Is your tax problem more complex?  If your issue is causing you financial hardship, you have tried repeatedly and are not receiving a response from the IRS, or you feel your taxpayer rights are being violated, consider contacting Taxpayer Advocate Service (TAS).

Do you feel that you need help from a tax professional but can’t afford one? You may be eligible for representation from an attorney, certified public accountant (CPA), or enrolled agent associated with a Low Income Taxpayer Clinic.

Last modified June 21, 2017