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Does Debt Cancellation Count as Taxable Income?

When you have part or all of your debt canceled by a lender, it may seem like a dream come true. Before celebrating too much, it is important that you understand other implications of this debt cancelation, including the impact on your federal income taxes. Most debt cancelations count towards your income, which means that you have to pay taxes on the amount. However, there are some exceptions that are important to know so that you do not pay tax if you are not required to do so.

Primary Residence Exception

Mortgages that cover your primary residence may qualify for an exemption for income in the case of debt cancellation. In order to exclude this from your income, it must be a mortgage that is secured by your main home. Additionally, this loan must have been used exclusively to buy your home, or it could have been used to build a house or substantially renovate your home. If the funds were used for anything else, then any debt cancellation cannot be excluded from your income.

Loan Modification Programs

A common reason for debt cancellation is a loan modification on a mortgage. This may also be known as a workout. In this case, it may be possible to exclude the amount cancelled as part of your income. If you have had your debt discharged by applying to the Home Affordable Modification Program (HAMP), then you most likely will not have to count it as income. It may be possible to also exclude these funds in the event of a foreclosure.

Refinancing

Many people have decided to take advantage of lower interest rates by refinancing their mortgages. When this happens, some of the debt may be cancelled. If you have a refinanced mortgaged that you use to buy, improve, or build your primary residence, then it may be possible to exempt this from your income. However, the amount not applicable to income can only be up to the old mortgage principal prior to refinancing.

Other Debt Cancelation

If you have any other debt cancelation, including that applied to secondary residences, rental or business property, car loans, or credit card debt, it does not qualify to be excluded like that associated with mortgages on primary residences. This means that it must be added to your income. However, some of these may fall under other rules that may allow you to exclude them in special cases. It may be to your benefit to research your type of debt cancelation to see if you can somehow get it excluded.

If you do have debt cancelation, then it is important that you include it on your tax return, especially if it counts as income. You should receive Form 1099-C from your lender if the amount canceled was more than $600. When you prepare your taxes, you will need to use Form 982 and follow the instructions. If you are unsure whether or not you qualify for an exclusion, then discuss your situation with a tax professional. A tax professional, like those a Fidelity Tax Relief, can also help you to file your tax return correctly to show the debt cancellation. Call us at 877-372-2520 today to see how we can help you with this or other tax resolution needs.

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