Is My Canceled Debt Taxable?

A bank has written off — canceled as uncollectable — a loan you were unable to pay off.  Forgiveness is good news, right? In this context, it’s a maybe! You see, the IRS considers write-offs to be taxable income. However, there are exceptions, which are good news for your bottom line.

Banks, credit unions, and other lending organizations are required to issue a Form 1099-C in the year a  ‘recognizable event’ involving a debt cancellation (of $600 or more) occurs. If you receive a  1099-C, the IRS will (most likely) also get a copy, so be sure to report and record it when you file your return.

In fact, It’s best if you include on your tax return any canceled debt over $600 you’re aware of — even if you didn’t get a 1099-C form — because if the IRS got a 1099-C for the canceled debt, it will seek to match it up in your return.  How do you know if the cancellation is taxable or not? First, let’s look at the most common recognizable events, the

Recognizable Events that Trigger Form 1099-C

  • Discharge in bankruptcy under Title 11
  • Cancellation or extinguishment in a court action such as foreclosure
  • Expiration of the statute of limitations to collect the debt
  • A discharge under an agreement between a debtor and lender
  • Discharge due to a lender’s policy to stop collection efforts when they determine a debt is uncollectable
  • The lender has not received a payment for the prior 36-month period ending on December 1st

Don’t Confuse 1099-A with 1099-C

Keep a sharp eye— don’t mistake a Form 1099-A for a Form 1099-C. The 1099-A (Acquisition or Abandonment of Secured Property) is used to report credit applied against your mortgage for a property that was foreclosed or signed over to the bank.

Non-Taxable Canceled Debt

As noted above, canceled debt produces taxable income unless it’s one of the exceptions, which include:

  • Debt that’s canceled as a gift, bequest, devise, or inheritance
  • Certain cancellations of student loans
  • Interest that was included with the principal that was written off
  • A qualified purchase price reduction is given by a seller

Canceled Debt Exclusions Include:

  • Debt canceled in a Title 11 bankruptcy case
  • Debt canceled during insolvency (your total liabilities exceed the value of your total assets (see IRS Publication 468)
  • Cancellation of qualified farm indebtedness
  • Cancellation of qualified real property business indebtedness
  • Qualified principal home indebtedness up to $2 million for married filing jointly that was canceled prior to 12/31/17

How to Handle an Erroneous 1099-C

If you believe that a 1099-C is in error, contact the lender and see if you can get them to correct it. Failing to accomplish that, report it on your tax return so that it will match the 1099-C and then deduct it and provide an explanation.

 Exclusions Aren’t  Fully Free

Canceled Debt exclusions are not a complete freebie. You must reduce certain tax attributes by the amount of cancellation, but not below zero. Tax attributes are a complicated subject. The best way to calculate the reductions is to use Part II of Form 982. Basically, you are reducing future tax benefits such as depreciable basis, net operating losses, and various credit carryforwards.

I look forward to serving you, saving you money, and releasing you from much of the stress and anxiety of dealing with the IRS. Please call 352-317-5692 or email me for your free phone consult.