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 almost all cases, cancelled debts are taxable. There are few circumstances where a cancelled debt is not taxable. One of these times occurs when debt was discharged through a bankruptcy. Another occurs if a person is considered insolvent. If a cancelled debt is taxable, the lender who cancelled the debt will send the person a 1099-C. This form is a cancellation of debt tax notice. If a consumer receives this, he should ask a tax advisor about it. In almost every circumstance, the person will be required to include this as income on his tax return.
Many states have different laws regarding cancelled debts; which means that depending on the state you live in, the federal laws might vary from the state laws. According to the IRS, forgiven debt, or cancelled debt, is income. Because of this philosophy, almost all cancelled debts must be claimed on a person’s federal tax returns. It is always important to ask a tax professional about this if you receive a 1099-C. There are a few exclusions, and it is possible that these might apply to you.
One of the most common times when this happens is when a person completes a debt settlement program. For example, if a person owes $5,000, but his creditors agree to accept only $3,000, the difference of $2,000 is considered income for the person. In this case, the lender will issue a 1099-C for $2,000 to this person. The person must then claim this as income on his tax return. Another time when this occurs is when a company writes off a debt. If a person owes a $3,000 bill, but the company considers it uncollectible, the company can issue the person a 1099-C. The form would be listed for the full amount of $3,000. This amount must be reported on the person’s tax return as income.
If property secured your debt and the lender takes that property 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
One common way that people avoid this is by filing bankruptcy. All debts cleared through a bankruptcy are considered forgiven, and are not subject to taxes.
If you need help filing your personal tax return or have other questions regarding federal or state tax, you can contact us at GKM on info@gkmtax.com.
