With the ups and downs of our economy over the past 2 years, you may have had a loan or credit card balance canceled or waived by a financial institution. You would think that debt cancellation by a credit card company or a mortgage company would be a good thing for you and your family. And it is possible, but it can also be considered taxable income by the IRS. Here is a quick overview of various debt cancellation situations.
• Consumer debt. If you have gone through a consumer debt credit restructuring program, it is likely that some of your debt has been forgiven. If so, be prepared to receive IRS Form 1099-C representing the amount of debt forgiven. The IRS considers this amount to be taxable income to you and expects it to appear on your tax return. The exception is if you declare bankruptcy. In the event of bankruptcy, the canceled debt is generally not taxable.
Even if you are not legally bankrupt, you could be technically insolvent when your liabilities exceed your assets. If so, you can exclude your debt forgiveness income by declaring your financial situation and filing IRS Form 982 with your tax return.
• Principal residence. If your home is sold short or foreclosed and the lender receives less than the full outstanding loan amount, expect the debt forgiveness amount to be reported to you and the IRS. . But special rules allow you to exclude up to $2 million in cancellation revenue under many circumstances. You’ll have to file IRS Form 982 again, but the exclusion from taxable income caused by the cancellation of your principal residence debt is incredibly liberal. So be sure to take advantage of these rules if they apply to you.
• Student loans. If your school closes while you enroll or shortly after you withdraw, you may be eligible to have your federal student loan forgiven and not include the surrendered amount as taxable income. You may also have the right to exclude from taxable income any student loans canceled because your school misled you or engaged in other misconduct in violation of certain state laws.
• Secondary residence, rental building, apartment building, professional building. Debt cancellation rules on second homes, rental properties, and investment or business properties can be extremely complicated. Given the cost of these properties, your financial situation and the amount of debt forgiven, it is always possible that this debt forgiveness income could be taxed at a preferential capital gains rate, or even considered tax-free at all. .
One of my main goals is to help you achieve your financial goals through a holistic and tax efficient approach in my wealth management and tax resolution practice. For more information, visit www.fredtfoxiii.com.
Fred T. Fox III is a Lawton financial advisor who writes a weekly financial column for The Lawton Constitution.