A debt for these purposes includes any deficit whether you are personally liable or liable only to the extent of the property securing the debt. If all or part of that debt is secured by property then cancellation may occur because of foreclosure repossession voluntary return of the property to the lender abandonment of the property or a principal residence loan modification.
In general if you are liable for a debt that is cancelled forgiven or discharged you will receive the Cancellation of Debt Form-1099-C. The canceled amount in gross income must be included on your taxes unless you qualify for an exclusion or an exception. If you receive a Form 1099-C but the creditor is continuing to try to collect the debt then the debt has not been fully cancelled and you do not have taxable cancellation of debt income.
Any taxable amount of cancelled debt for which you are personally liable must be reported as ordinary income. You must report the taxable amount of a taxable debt whether or not you receive Form 1099-C. If you received a Form 1099-C and the information is incorrect contact the lender to make corrections.
Although it is a separate issue if your debt is secured by property and that property is taken by the lender as a full or partial satisfaction of your debt you are treated as having sold that property and may have a taxable gain or loss.
Cancelled debts that meet the requirements for any of the following exceptions or exclusions are not taxable.
Cancelled Debt that Qualifies for EXCEPTION to Inclusion in Gross Income:
- Amounts specifically excluded from income by law such as gifts or bequests
- Cancellation of certain qualified student loans
- Canceled debt that if paid by a cash basis taxpayer would be deductible
- A qualified purchase price reduction given by a seller
- Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program
Cancelled Debt that Qualifies for EXCLUSION from Gross Income:
- Debt cancelled in a Title 11 bankruptcy case
- Debt cancelled during insolvency
- Cancellation of qualified farm indebtedness
- Cancellation of qualified real property business indebtedness
- Cancellation of qualified principal residence indebtedness
Homeowners involved in the mortgage foreclosure crisis currently affecting much of the country will be allowed a tax relief exclusion for “qualified principal residence indebtedness.” This exclusion allows taxpayers to exclude up to $2000000 ($1000000 if married filing separately) of “qualified principal residence indebtedness.”
If you do choose the exclusion from cancelled debt from income under one of the exclusions listed above you must reduce your positive tax attributes (certain credits losses basis of assets etc.) within limits by the amount excluded. You must also file Form 982 Reduction 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 certain tax attributes.