While debt cancellation can provide significant relief for consumers, many people are unaware of or unfamiliar with the tax implications of debt cancellation. Generally speaking, cancelled debt is considered income and income tax is owed on the amount of cancelled debt. However, some exclusions exist.
Here, we break down the tax implications of debt cancellation to make it easy.
Exceptions to the Rule
If the debt cancellation was on a mortgage for your primary home, you may not have to include the amount in your earned income. There are additional stipulations such as that the funds must have been used to buy, improve, or build your home and your home must be listed as security on the mortgage. An accountant can assist you in determining whether your primary home debt cancellation is considered income.
Other situations in which the cancelled debt may not be income include a refinanced mortgaged when the funds are used to buy or upgrade a home, and loan modification when it results in cancellation of part of or whole mortgage amount. An accountant can assist you in determining whether your mortgage-related debt cancellation is considered income.
When Tax is Due
Cancelled debt on credit card balances, auto loans, vacation homes, rental homes, and business property typically do not fall under an exception. This means that debt cancellation in any of these realms is typically considered taxable income. However, because some exceptions may still apply, consulting an accountant at Shockley Bookkeeping for guidance is the safest way to ensure proper planning and reporting of debt cancellation.
Understanding Tax Forms
There are two key tax forms used in debt cancellation situations:
- Form 1099-C reports the amount of the cancelled debt if it exceeds $600. This form should be submitted to your accountant during tax time to be incorporated into your year-end taxes.
- Form 982 reports excluded debt to prevent being taxed on the cancelled balance and should also be filed with your annual taxes.
To learn more about the tax implications of debt cancellation, consult Shockley Bookkeeping and Tax today!