Per IRS Tax Topic 431 Canceled Debt - Is It Taxable or Not?

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 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, 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.

In general, you must report any taxable amount of a canceled debt as ordinary income from the cancellation of debt on Form 1040 (PDF), U.S. Individual Income Tax Return, Form 1040NR (PDF), U.S. Nonresident Alien Income Tax Return, if the debt is a nonbusiness debt, or an applicable schedule if the debt is a business debt, as explained in Publication 4681 (PDF), 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 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 for the amount of the canceled debt and may have a taxable gain or loss. The gain or loss on 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.

Amounts that meet the requirements for any of the following exceptions aren't cancellation of debt income.

EXCEPTION to Cancellation of Debt Income:

1. Amounts canceled as gifts, bequests, devises, or inheritances
2. Certain qualified student loans canceled under the loan provisions that the loans would be canceled if you work for a certain period of time in certain professions for a broad class of employers
3. Certain other education loan repayment or loan forgiveness programs to help provide health services in certain areas.
4. Amounts of canceled debt that would be deductible if you, as a cash basis taxpayer, paid it
5. A qualified purchase price reduction given by the seller of property to the buyer
6. Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program

Amounts that meet the requirements for any of the following exclusions aren't included in income, even though they're cancellation of debt income.

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

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 attach to your tax return a 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.

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. Publication 525, Taxable and Nontaxable Income, contains additional information. If you received a Form 1099-A Acquisition or Abandonment of Secured Property, review Topic 432 for more information.