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Rev. date: 08/19/2014

Canceled Debt – Is It Taxable or Not?

Tax Topic 431
A debt includes any indebtedness whether you are personally liable or liable only to the extent of the property securing the debt. Cancellation of all or part of a debt that is secured by property may occur because of a foreclosure, a repossession, a 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 canceled, forgiven, or discharged, you will receive a Form 1099-C, Cancellation of Debt, and must include the canceled amount in gross income unless you meet an exclusion or exception. If you receive a Form 1099-C but the creditor is continuing to try to collect the debt, the creditor may not have canceled the debt. You should verify with the creditor your specific situation; you might not have cancellation of debt or taxable income.
You must report any taxable amount of a canceled debt for which you are personally liable, as ordinary income from the cancellation of debt, on Form 1040 or Form 1040-NR and associated schedules, as advised in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). You must report the taxable amount of a taxable canceled debt whether or not you receive a Form 1099-C.
Caution: If your debt is secured by property and that property is taken by the lender in full or partial satisfaction of 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 deemed sale of your property is an issue separate from whether any cancellation of debt income associated with that same property is includable in gross income. See Publication 544, Sales and Other Dispositions of Assets, and Publication 523, Selling Your Home for detailed information on reporting gain or loss from repossession, foreclosure or abandonment of property.
Canceled debts that meet the requirements for any of the following exceptions or exclusions are not taxable.

Debt Cancellations or Reductions that Qualify for EXCEPTION to Inclusion in Gross Income:

  1. Amounts specifically excluded from income by law such as gifts, bequests, devises or inheritances
  2. Cancellation of certain qualified student loans
  3. Canceled debt, that if it were paid by a cash basis taxpayer, would be deductible
  4. A qualified purchase price reduction given by a seller
  5. Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program

Canceled Debt that Qualifies for EXCLUSION from Gross Income:

  1. Debt canceled in a Title 11 bankruptcy case
  2. Debt canceled during insolvency
  3. Cancellation of qualified farm indebtedness
  4. Cancellation of qualified real property business indebtedness
  5. Cancellation of qualified principal residence indebtedness
The exclusion for "qualified principal residence indebtedness" provides tax relief on canceled debt for many homeowners involved in the mortgage foreclosure crisis currently affecting much of the United States. The exclusion allows taxpayers to exclude up to $2,000,000 ($1,000,000 if married filing separately) of canceled "qualified principal residence indebtedness." NOTE: The exclusion for cancellation of qualified principal residence indebtedness expired December 31, 2013. You may claim it on your tax year 2013 tax return if you qualify. Under current law, the exclusion is not available for tax years after 2013.
Generally, if you exclude canceled 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 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. For cancellation of qualified principal residence indebtedness that you exclude from income, you must only reduce your basis in your principal residence.
If you received a Form 1099-C and the information is incorrect, contact the lender to make corrections. Refer to Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals), for more detailed information regarding taxability of canceled debt, how to report it, and related exceptions and exclusions. Additional information can also be found in Publication 525, Taxable and Nontaxable Income. If you received a Form 1099-A, Acquisition or Abandonment of Secured Property, review Tax Topic 160 for additional information.