If you borrow money and legally obligated to repay a fixed or determinable amount at a future date, you have a debt; but there is a debt cancellation law.
According to the IRS, you may be personally liable for a debt or may own a property that’s subject to a debt.
If your debt is forgiven or discharged for less than the full amount you owe, the debt is considered canceled in the amount that you don’t have to pay.
The law provides several exceptions, however, in which the amount you don’t have to pay isn’t canceled debt.
These exceptions will be discussed later.
Cancellation of a debt may occur if the creditor can’t collect, or gives up on collecting, the amount you’re obligated to pay.
If you own property subject to a debt, cancellation of the debt also may occur because of a:
In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.
The canceled debt isn’t taxable, however, if the law specifically allows you to exclude it from gross income.
These specific exclusions will be discussed later.
After a debt is canceled, the creditor may send you a Form 1099-C, Cancellation of Debt (PDF) showing the amount of cancellation of debt and the date of cancellation, among other things.
If you received a Form 1099-C showing incorrect information, contact the creditor to make corrections.
For example, if the creditor is continuing to try to collect the debt after sending you a Form 1099-C, the creditor may not have canceled the debt and, as a result, you may not have income from a canceled debt.
You should verify with the creditor your specific situation.
Your responsibility to report the taxable amount of canceled debt as income on your tax return for the year when the cancellation occurs doesn’t change whether or not you receive a correct Form 1099-C.
In general, you must report any taxable amount of a canceled debt as ordinary income from the cancellation of debt on Form 1040, U.S. Individual Income Tax Return (PDF), Form 1040-SR, U.S. Tax Return for Seniors (PDF) or Form 1040-NR, U.S. Nonresident Alien Income Tax Return (PDF) as “other income” if the debt is a nonbusiness debt, or an applicable schedule if the debt is a business debt.
Caution: If property secured your debt and the creditor takes that property in full or partial satisfaction of your debt, you’re treated as having sold that property to the creditor. Your tax treatment depends on whether you were personally liable for the debt (recourse debt) or not personally liable for the debt (nonrecourse debt).
If your property was subject to a recourse debt, your amount realized is the fair market value (FMV) of the property.
Your ordinary income from the cancellation of the debt is the amount of the debt in excess of the FMV of the property that the lender forgives.
You must include this cancellation of debt in your income unless an exception or exclusion, discussed below, applies.
The difference between the FMV and your adjusted basis (usually your cost) will be gain or loss on the disposition of the property.
If your property was subject to a nonrecourse debt, your amount realized is the entire amount of the nonrecourse debt plus the amount of cash and the FMV of any property you received.
You will not have ordinary income resulting from debt cancellation.
The examples below show the difference between how recourse and nonrecourse debt is treated.
See Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) (PDF) for detailed information on canceled debt and on reporting gain or loss from repossession, foreclosure, or abandonment of property.
Amounts that meet the requirements for any of the following exceptions aren’t cancellation of debt income.
Amounts that meet the requirements for any of the following exclusions aren’t included in income, even though they’re cancellation of debt income.
Generally, if you exclude canceled debt from income under one of the exclusions listed above, you must reduce certain tax attributes (certain credits and carryovers, losses and carryovers, basis of assets, etc.) (but not below zero) by the amount excluded.
You must attach to your tax return a Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) (PDF) to report the amount qualifying for exclusion and any corresponding reduction of those tax attributes.
For cancellation of qualified principal residence indebtedness that you exclude from income, you must only reduce your basis in your principal residence.
Refer to Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) (PDF) for more detailed information regarding taxability of canceled debt, how to report it, and related exceptions and exclusions. Publication 525, Taxable and Nontaxable Income contains additional information.
If you received a Form 1099-A, Acquisition or Abandonment of Secured Property (PDF), review Topic No. 432 for more information.
Refer to Do I Have Cancellation of Debt Income on My Personal Residence? to determine if any of the debt canceled on your principal residence is required to be included as income on your federal tax return.