Table of Contents
This chapter discusses the tax treatment of canceled debts.
Generally, if a debt for which you are personally liable is forgiven or discharged for less than the full amount owed, the debt is considered canceled in whatever amount it remained unpaid. There are exceptions to this rule, discussed under Exceptions , later. Generally, you must include the canceled debt in your income. However, you may be able to exclude the canceled debt. See Exclusions , later.
John owed $1,000 to Mary. Mary agreed to accept and John paid $400 in satisfaction of the entire debt. John has canceled debt of $600.
Margaret owed $1,000 to Henry. Henry and Margaret agreed that Margaret would provide Henry with services (instead of money) in full satisfaction of the debt. Margaret does not have canceled debt. Instead, she has income from services.
A debt includes any indebtedness:
For which you are liable, or
Subject to which you hold property.
Debt for which you are personally liable is recourse debt. All other debt is nonrecourse debt.
If you are not personally liable for the debt, you do not have ordinary income from the cancellation of debt unless you retain the collateral and either:
The lender offers a discount for the early payment of the debt, or
The lender agrees to a loan modification that results in the reduction of the principal balance of the debt.
See Discounts and Loan Modifications , later.
However, upon the disposition of the property securing a nonrecourse debt, the amount realized includes the entire unpaid amount of the debt, not just the FMV of the property. As a result, you may realize a gain or loss if the outstanding debt immediately before the disposition is more or less than your adjusted basis in the property. For more details on figuring your gain or loss, see chapter 2 of this publication or see Publication 544, Sales and Other Dispositions of Assets.
There are several exceptions and exclusions that may result in part or all of a canceled debt being nontaxable. See Exceptions and Exclusions, later. You must report any taxable canceled debt as ordinary income on:
Form 1040 or Form 1040NR, line 21, if the debt is a nonbusiness debt;
Schedule C (Form 1040), line 6 (or Schedule C-EZ (Form 1040), line 1), if the debt is related to a nonfarm sole proprietorship;
Schedule E (Form 1040), line 3, if the debt is related to nonfarm rental of real property;
Form 4835, line 6, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or
Schedule F (Form 1040), line 8, if the debt is farm debt and you are a farmer.
If you receive a Form 1099-C, that means an applicable entity has reported an identifiable event to the IRS regarding a debt you owe. The identifiable event may be an actual cancellation of the debt or it may be an event the applicable entity is required, solely for purposes of reporting to the IRS, to treat as a cancellation of debt. For information on the reasons an applicable entity files Form 1099-C, see Identifiable event codes, next. Unless you meet one of the exceptions or exclusions discussed later, this canceled debt is ordinary income and must be reported on the appropriate form discussed above.
A financial institution.
A credit union.
Any of the following, its successor, or subunit of one of the following:
The Federal Deposit Insurance Corporation (FDIC),
The Resolution Trust Corporation (RTC),
The National Credit Union Administration (NCUA), or
Any other federal executive agency, including government corporations, any military department, the U.S. Postal Service, or the Postal Rate Commission.
A corporate subsidiary of a financial institution or credit union (if the affiliation subjects the subsidiary to federal or state regulation).
A federal government agency, including a department, an agency, a court or court administrative office, or a judicial or legislative instrumentality.
Any organization a significant trade or business of which is lending money.
Codes A through G and I identify specific occurrences involving an actual discharge of indebtedness. However, Code H, Expiration of nonpayment testing period, identifies an occurrence that does not necessarily involve an actual discharge of indebtedness.
Code A — Bankruptcy. Code A is used to identify cancellation of debt as a result of a title 11 bankruptcy case. See Bankruptcy , later.
Code B — Other judicial debt relief. Code B is used to identify cancellation of debt as a result of a receivership, foreclosure, or similar federal or state court proceeding other than bankruptcy.
Code C — Statute of limitations or expiration of deficiency period. Code C is used to identify cancellation of debt either when the statute of limitations for collecting the debt expires or when the statutory period for filing a claim or beginning a deficiency judgment proceeding expires. In the case of the expiration of a statute of limitations, an identifiable event occurs only if and when your affirmative defense of the statute of limitations is upheld in a final judgment or decision in a judicial proceeding, and the period for appealing the judgment or decision has expired.
Code D — Foreclosure election. Code D is used to identify cancellation of debt when the creditor elects foreclosure remedies that statutorily end or bar the creditor's right to pursue collection of the debt. This event applies to a mortgage lender or holder who is barred from pursuing debt collection after a power of sale in the mortgage or deed of trust is exercised.
Code E — Debt relief from probate or similar proceeding. Code E is used to identify cancellation of debt as a result of a probate court or similar legal proceeding.
Code F — By agreement. Code F is used to identify cancellation of debt as a result of an agreement between the creditor and the debtor to cancel the debt at less than full consideration.
Code G — Decision or policy to discontinue collection. Code G is used to identify cancellation of debt as a result of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. For purposes of this identifiable event, a defined policy includes both a written policy and the creditor's established business practice.
Code H — Expiration of nonpayment testing period. Code H is used to indicate that the creditor has not received a payment on the debt during a testing period ending on December 31, 2014. The testing period is a 36-month period increased by the number of months the creditor was prevented from engaging in collection activity by a stay in bankruptcy or similar bar under state or local law. This identifiable event applies only for a creditor that is a financial institution or credit union (and certain of their subsidiaries), the FDIC, the RTC, the NCUA, any other federal executive agencies, and any successor or subunit of the FDIC, the RTC, the NCUA, or a federal executive agency.
Expiration of the nonpayment testing period does not necessarily result from an actual discharge of indebtedness.
Code I — Other actual discharge before identifiable event. Code I is used to identify an actual cancellation of debt that occurs before any of the identifiable events described in codes A through H.
|B||Other judicial debt relief|
|C||Statute of limitations or expiration of deficiency period|
|E||Debt relief from probate or similar proceeding|
|G||Decision or policy to discontinue collection|
|H||Expiration of nonpayment testing period|
|I||Other actual discharge before identifiable event|
The amount of debt proceeds each person received,
How much of any interest deduction from the debt was claimed by each person,
How much of the basis of any co-owned property bought with the debt proceeds was allocated to each co-owner, and
Whether the canceled debt qualifies for any of the exceptions or exclusions described in this publication.
If a lender discounts (reduces) the principal balance of a loan because you pay it off early, or agrees to a loan modification (a “workout”) that includes a reduction in the principal balance of a loan, the amount of the discount or the amount of principal reduction is canceled debt. However, if the debt is nonrecourse and you did not retain the collateral, you do not have cancellation of debt income. The amount of the canceled debt must be included in income unless one of the exceptions or exclusions described later applies. For more details, see Exceptions and Exclusions, later.
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