Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.
If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the amount on Schedule C (Form 1040) or Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, if the debt is farm debt and you are a farmer).
If the debt is a business debt, you may be able to elect to recognize the canceled debt in income over a 5 tax year period. For information on this election, see Revenue Procedure 2009-37 available at http://www.irs.gov/irb/2009-36_IRB/ar07.html
If a Federal Government agency, financial institution, or credit union 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.taxmap/pub17/p17-063.htm#en_us_publink1000171953
If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest also will be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible if you paid it. See Deductible debt
, under Exceptions
If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from Form 1099-C, box 2. If the interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the amount shown in box 2 less the interest amount shown in box 3). taxmap/pub17/p17-063.htm#en_us_publink1000171956
If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount is canceled debt. You must include the canceled amount in your income.taxmap/pub17/p17-063.htm#en_us_publink1000171957
If you are personally liable for a mortgage (recourse debt), and you are relieved of the mortgage when you dispose of the property, you may realize gain or loss up to the fair market value of the property. To the extent the mortgage discharge exceeds the fair market value of the property, it is income from discharge of indebtedness unless it qualifies for exclusion under Excluded debt
, later. Report any income from discharge of indebtedness on nonbusiness debt that does not qualify for exclusion as other income on Form 1040, line 21.
You may be able to exclude part of the mortgage relief on your principal residence. See Excluded debt
If you are not personally liable for a mortgage (nonrecourse debt), and you are relieved of the mortgage when you dispose of the property (such as through foreclosure or repossession), that relief is included in the amount you realize. You may have a taxable gain if the amount you realize exceeds your adjusted basis in the property. Report any gain on nonbusiness property as a capital gain.
See Publication 4681 for more information.taxmap/pub17/p17-063.htm#en_us_publink1000171961
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.
If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not realize income. This is because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal that you canceled.taxmap/pub17/p17-063.htm#en_us_publink1000171962
If you included a canceled amount in your income and later pay 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 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 due date of your original return.taxmap/pub17/p17-063.htm#en_us_publink1000171963
There are several exceptions to the inclusion of canceled debt in income. These are explained next.taxmap/pub17/p17-063.htm#en_us_publink1000171964
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 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
- 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. Section 501(c)(3) organizations are defined in chapter 24.
A loan to refinance a qualified student loan also will qualify if it was made by an educational institution or a tax-exempt 501(a) organization under its program designed as described in (3)(b) above. taxmap/pub17/p17-063.htm#en_us_publink1000171965
Education loan repayments made to you by the National Health Service Corps Loan Repayment Program (NHSC 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/pub17/p17-063.htm#en_us_publink1000171966
You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception applies only if you use the cash method of accounting. For more information, see chapter 5 of Publication 334, Tax Guide for Small Business.taxmap/pub17/p17-063.htm#en_us_publink1000171967
Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from the reduction. The reduction of the debt is treated as a purchase price adjustment and reduces your basis in the property.taxmap/pub17/p17-063.htm#en_us_publink1000171968
Do not include a canceled debt in your gross income in the following situations.
- The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
- The debt is canceled when you are insolvent. However, you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent. See Publication 908.
- The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Publication 225, Farmer's Tax Guide.
- The debt is qualified real property business debt. See chapter 5 of Publication 334.
- The cancellation is intended as a gift.
- The debt is qualified principal residence indebtedness. See Publication 525 for additional information.