Generally, if a debt for which you are personally liable is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. A debt includes any indebtedness for which you are liable or which attaches to property you hold. 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 the lender offers a discount for the early payment of the debt or agrees to a loan modification that results in the reduction of the principal balance of the debt. See Discounts and loan modifications, later. Also, upon the disposition of the property securing a nonrecourse debt, the amount realized includes the entire unpaid amount of the debt. As a result, you may realize a gain or loss if the outstanding debt immediately before the transfer differs from your adjusted basis in the property to which the debt relates. See Chapter 2, Foreclosures and Repossessions, in this publication; or Publication 544, Sales and Other Dispositions of Assets; for more details on figuring your gain or loss.
There are several exceptions and exclusions that may result in part or all of your income from the cancellation of debt being nontaxable. See Exceptions
later. You must report any taxable amount as ordinary income from the cancellation of debt 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 a nonfarm rental activity;
- 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 10, if the debt is farm debt and you are a farmer.
If an applicable financial entity cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2. Unless you meet one of the exceptions or exclusions discussed later, the canceled debt shown on Form 1099-C, box 2, is ordinary income from the cancellation of debt and must be reported on the appropriate form shown above.
An applicable financial entity includes:
- A federal government agency,
- A financial institution,
- A credit union, or
- Any organization in which a significant part of its trade or business involves the lending of money.
If any interest is forgiven and included in the amount of canceled debt in box 2, the interest portion that is included in box 2 will be shown in box 3. Whether the interest portion of the canceled debt must be included in your income depends on whether the interest would be deductible if you paid it. See Deductible Debt under Exceptions, later.
If the interest would not be deductible (such as interest on a personal loan) and you do not meet any other exception or exclusion discussed later, include in your income the amount from Form 1099-C, box 2. If the interest would be deductible (such as on a business loan) and you do not meet any other exception or exclusion discussed later, include in your income the net amount of the canceled debt (the amount shown in box 2 minus the interest amount shown in box 3).taxmap/pubs/p4681-001.htm#en_us_publink100080224
If a lender offers to discount (reduce) the principal balance of a loan if the loan is paid 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 whether or not you are personally liable for the debt. The amount of the canceled debt must be included in income unless certain exceptions or exclusions apply. For more details, see Exceptions and Exclusions, later.taxmap/pubs/p4681-001.htm#en_us_publink100080225
If you owned property which was subject to a recourse debt in excess of the FMV of the property, the lender's foreclosure or repossession of the property may result in your realization of gain or loss on the disposition of the property. If the lender forgives all or part of the amount of the debt in excess of the FMV of the property, ordinary income may result from the cancellation of debt. The gain or loss on the disposition of the property is measured by the difference between the FMV of the property at the time of the disposition and your adjusted basis (usually your cost) in the property. The character of the gain or loss (such as ordinary or capital) on the disposition of the property is determined on the basis of the character of the property foreclosed. The ordinary income from the cancellation of debt (the excess of the canceled debt over the FMV of the property) must be included on your tax return unless certain exceptions or exclusions apply. For more details, see Exceptions and Exclusions, later.
If you owned property which was subject to a nonrecourse debt in excess of the FMV of the property, the lender's foreclosure on the property does not result in ordinary income from the cancellation of debt. The entire amount of the nonrecourse debt is treated as an amount realized on the disposition of the property. The gain or loss on the disposition of the property is measured by the difference between the total amount realized (the entire amount of the nonrecourse debt plus the amount of cash and the FMV of any property received) and your adjusted basis in the property foreclosed. The character of the gain or loss on the disposition of the property is determined on the basis of the character of the property foreclosed.
See Publication 523, Selling Your Home; Publication 544, Sales and Other Dispositions of Assets; Chapter 2, Foreclosures and Repossessions, in this publication; and Publication 551, Basis of Assets; for more details.taxmap/pubs/p4681-001.htm#en_us_publink100080226
If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you will realize ordinary income equal to the canceled debt. You must report this income on your return unless certain exceptions or exclusions apply. For more details, see Exceptions and Exclusions, later. This income is separate from any loss realized from the abandonment of the property. For more details, see Chapter 3, Abandonments.taxmap/pubs/p4681-001.htm#en_us_publink100080227
If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution that is generally dividend income to you. For more information, see Publication 542, Corporations.taxmap/pubs/p4681-001.htm#en_us_publink100080228
If you included a canceled amount in your income and later pay all or a portion of the debt, you may be able to file a claim for refund for the year the amount was included in income. You can file a claim on Form 1040X, Amended U.S. Individual Income Tax Return, if the statute of limitations for filing a claim is still open. The statute of limitations generally does not end until 3 years after the date you filed the original return or within 2 years after the date you paid the tax, whichever is later.taxmap/pubs/p4681-001.htm#en_us_publink100080229
There are several exceptions to the inclusion of canceled debt in income. These exceptions apply before the exclusions discussed later.taxmap/pubs/p4681-001.htm#en_us_publink100080230
Amounts otherwise excluded from income do not result in income from the cancellation of debt. For example, you have no income from the cancellation of debt if the cancellation of the debt is intended as a gift to you. See Publication 525, Taxable and Nontaxable Income, for more details on amounts that are excluded from income.taxmap/pubs/p4681-001.htm#en_us_publink100080231
Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if you work for a certain period of time in certain professions for any of a broad class of employers.
You do not have income from the cancellation of debt if your student loan is canceled after you agreed to this provision and then performed the services required. To qualify, the loan must have been made by:
- The federal government, a state or local government, or an instrumentality, agency, or subdivision thereof,
- A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law, or
- An educational institution (defined later):
- Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
- As part of a program of the institution designed to encourage students to serve in occupations or areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization (defined later).
A loan to refinance a qualified student loan also will qualify if it was made by an educational institution or a tax-exempt section 501(a) organization under its program designed as described in (3)(b) above.taxmap/pubs/p4681-001.htm#en_us_publink100080232
You have ordinary income from the cancellation of debt if your student loan was made by an educational institution and is canceled because of services you performed for the institution or other organization that provided the funds. You must include this income on your return unless other exceptions or exclusions apply.taxmap/pubs/p4681-001.htm#en_us_publink100080233
Education loan repayments made to you by the National Health Service Corps Loan Repayment Program or a state education loan repayment program eligible for funds under the Public Health Service Act are not taxable if you agree to provide primary health services in health professional shortage areas.taxmap/pubs/p4681-001.htm#en_us_publink100080234
An educational institution is an organization with a regular faculty and curriculum and a regularly enrolled body of students in attendance at the place where the educational activities are carried on.taxmap/pubs/p4681-001.htm#en_us_publink100080235
A section 501(c)(3) organization is any corporation, community chest, fund, or foundation organized and operated exclusively for one or more of the following purposes.
- Fostering national or international amateur sports competition (but only if none of the organization's activities involve providing athletic facilities or equipment).
- Preventing cruelty to children or animals.
- Testing for public safety.
If you use the cash method of accounting, you do not realize income from the cancellation of debt if the payment of the debt would have been a deductible expense. This exception applies before the price reduction exception discussed below.taxmap/pubs/p4681-001.htm#en_us_publink100080237
You get accounting services for your farm on credit. Later, you have trouble paying your farm debts and your accountant forgives part of the amount you owe for the accounting services. How you treat the canceled debt depends on your method of accounting.
- Cash method. You do not include the canceled debt in income because payment of the debt would have been deductible as a business expense.
- Accrual method. Unless another exception or exclusion applies, you must include the canceled debt in ordinary income because the expense was deductible when you incurred the debt.
If debt you owe the seller for the purchase of property is reduced by the seller at a time when you are not insolvent and the reduction does not occur in a title 11 bankruptcy case, the reduction does not result in cancellation of debt income. However, you must reduce your basis in the property by the amount of the reduction of your debt to the seller. The rules that apply to bankruptcy and insolvency are explained in the next section, Exclusions.