Canceled Debt – Is It Taxable or Not?
If you borrow money and are legally obligated to repay a fixed or determinable amount at a future date, you have a debt. You may be personally liable for a debt or may own a property that is 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 do not have to pay. Cancellation of a debt may occur if the creditor cannot collect, or gives up on collecting, the amount you are obligated to pay. If you own property subject to a debt, cancellation of the debt also may occur because of a foreclosure, a repossession, a voluntary transfer of the property to the lender, abandonment of the property, or a mortgage 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 is not taxable, however, if the law specifically allows you to exclude it from gross income.
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. Your responsibility to report the taxable amount of canceled debt as income on your tax return for the year when the cancellation occurs does not 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 your Individual Income Tax Return if the debt is a nonbusiness debt, or on the applicable schedule if the debt is a business debt.
If property secured your debt and the creditor takes that property in full or partial satisfaction of your debt, you are treated as having sold that property for the amount of the canceled debt and you 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. Amounts that meet the requirements for any of the following exceptions are not cancellation of debt income.
EXCEPTIONS to Cancellation of Debt Income:
- Amounts canceled as gifts, bequests, devises, or inheritances
- 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
- Amounts of canceled debt that would be deductible if you, as a cash basis taxpayer, paid it
- A qualified purchase price reduction given by the seller of property to the buyer
- 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 are not included in income, even though they are cancellation of debt income.
EXCLUSIONS from Gross Income:
- Debt canceled in a Title 11 bankruptcy case
- Debt canceled during insolvency
- Cancellation of qualified farm indebtedness
- Cancellation of qualified real property business indebtedness
- Cancellation of qualified principal residence indebtedness (applies to debt discharged before January 1, 2017)
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, 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.
For NJ purposes Cancellation of Debt is exempt from income tax.
