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Cancelled Debt Income
If it’s been a rough number of years for you recently, you’re not alone. Many Americans lost their homes to foreclosure following the 2008 financial crisis. Even today, many Americans are still facing foreclosure action or are unable to sustain paying their bills. If you experienced this, I am sure you are hoping the worst is behind you…. But to add insult to injury, if you went through foreclosure, had a short sale of your house or simply had a balance forgiven on a credit card, then you most likely will be receiving a 1099-C – Cancellation Debt Income form in the mail taxing you for the amount of debt that was forgiven. This Cancelled Debt Income is a potential tax nightmare for some, as if it was bad enough that you lost your property, well now you might have to pay taxes on it!
According to the IRS, if your debt is canceled, forgiven or discharged you will receive a Form 1099-C, Cancellation of Debt, and you must include the canceled amount in gross income unless you meet an exclusion or exception.
Additionally, as in the case of your main home which secured your debt, if the lender takes your 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. This transaction is treated as a deemed sale at the fair market value of the property on the date of the foreclosure or other action. 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.
As a Certified Public Accountant, I can’t tell you how many times I’ve seen a tax preparer erroneously leave off the Cancelled Debt Income (from a 1099-C) from a taxpayers return or failed to properly exclude the cancelled debt income that is eligible for the exclusion. As part of our free CPA second opinion, we have reviewed hundreds of tax returns in which taxpayers erroneously paid too much tax on their Cancelled Debt Income, either through not consulting a qualified CPA or their preparer did not have the expertise needed and overlooked the available exclusions.
Canceled Debt Income that qualifies for EXCLUSION from gross income are:
- 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
Additionally, the exclusion for qualified principal residence indebtedness provides tax relief on canceled debt income for many homeowners involved in the mortgage foreclosure crisis still 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.
Also, please keep in mind, if you are eligible to exclude canceled debt income under one of the exclusions listed above, you must also reduce certain tax attributes (credits, losses, basis of assets, etc) by the amount of cancelled debt income that you were eligible to exclude, by filing Form 982 along with your tax return.
As always, as one of Orlando’s top Certified Public Accounting firms, please feel free to reach out to us if you should have any questions regarding Cancelled Debt Income and how it may apply to you.