This publication explains the federal tax treatment of canceled debts, foreclosures, repossessions, and abandonments.

Generally, if you owe a debt to someone else and they cancel or forgive that debt, you are treated for income tax purposes as having income and may have to pay tax on this income.

 

Sometimes a debt, or part of a debt, that you do not have to pay is not considered canceled debt. These exceptions are discussed later under Exceptions. And sometimes a canceled debt may be excluded from your income. But, if you do exclude canceled debt from income, you may be required to reduce your "tax attributes." These exclusions and the reduction of tax attributes are discussed later under Exclusions.

Foreclosure and repossession are remedies that your lender may exercise if you fail to make payments on your loan and you have previously granted that lender a security interest in some of your property. These remedies allow the lender to seize or sell the property securing the loan. When your property is foreclosed upon or repossessed and sold, you are treated as having sold the property and you may recognize taxable gain. Whether you also recognize income from canceled debt depends in part on whether you are personally liable for the debt and whether the outstanding loan balance is more than the fair market value (FMV) of the property. Figuring your gain or loss and canceled debt arising from a foreclosure or repossession is discussed later under Foreclosures and Repossessions.

Generally, you abandon property when you voluntarily and permanently give up possession and use of property you own with the intention of ending your ownership but without passing it on to anyone else. Figuring your gain or loss and canceled debt arising from an abandonment is discussed later under Abandonments.

This publication also includes detailed examples with filled-in forms.

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The sections of this publication that apply to you depend on the type of debt canceled, the tax attributes you have, and whether or not you continue to own the property that was subject to the debt. Some examples of common circumstances are provided in the following paragraphs to help guide you through this publication. These examples do not cover every canceled debt situation, but are intended to provide general guidance for the most common situations.

If you had a nonbusiness credit card debt canceled, you may be able to exclude the canceled debt from income if the cancellation occurred in a title 11 bankruptcy case or you were insolvent immediately before the cancellation. You should read Bankruptcy or Insolvency under Exclusions in chapter 1 to see if you can exclude the canceled debt from income under one of those provisions. If you can exclude part or all of the canceled debt from income, you should also read Bankruptcy and Insolvency under Reduction of Tax Attributes in chapter 1.

If you had a personal vehicle repossessed and disposed of by the lender during the year, you will need to determine your gain or nondeductible loss on the disposition. This is explained in chapter 2 . If the lender also canceled all or part of the remaining amount of the loan, you may be able to exclude the canceled debt from income if the cancellation occurred in a title 11 bankruptcy case or you were insolvent immediately before the cancellation. You should read Bankruptcy or Insolvency under Exclusions in chapter 1 to see if you can exclude the canceled debt from income under one of those provisions. If you can exclude part or all of the canceled debt from income, you should also read Bankruptcy and Insolvency under Reduction of Tax Attributes in chapter 1.

If a lender foreclosed on your main home during the year, you will need to determine your gain or loss on the foreclosure. Foreclosures are explained in chapter 2 and abandonments are explained in chapter 3. If the lender also canceled all or part of the remaining amount on the mortgage loan and you were personally liable for the debt, you should also read Qualified Principal Residence Indebtedness under Exclusions in chapter 1 to see if you can exclude part or all of the canceled debt from income. Detailed Example 2 and Example 3 in chapter 4 use filled-in forms to help explain these provisions.

If a lender agrees to a mortgage loan modification (a "workout") that includes a reduction in the principal balance of the loan, you should read Qualified Principal Residence Indebtedness under Exclusions in chapter 1 to see if you can exclude part or all of the canceled debt from income. If you can exclude part or all of the canceled debt from income, you should also read Qualified Principal Residence Indebtedness under Reduction of Tax Attributes in chapter 1. Detailed Example 1 in chapter 4 uses filled-in forms to help explain the tax implications of a mortgage workout scenario.