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. However, exceptions to the general rule that canceled debt is included in income may apply. See Exceptions, later. And, even if no exception applies, you still may be allowed to exclude the canceled debt from your income. See Exclusions, later.

A debt includes any indebtedness:

• For which you are liable, or
• Subject to which you hold property.

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 you retain the collateral and either:

• The lender offers a discount for the early payment of the debt or
• The lender 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, not just the FMV of the property. As a result, you may realize a gain or loss if the outstanding debt immediately before the disposition is more or less than your adjusted basis in the property. For more details on figuring your gain or loss, see chapter 2 of this publication or see Publication 544.

There are several exceptions and exclusions that may result in part or all of a canceled debt being nontaxable. See Exceptions and Exclusions, later. You must report any taxable cancelled debt as ordinary income 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 1b), if the debt is related to a nonfarm sole proprietorship;
• Schedule E (Form 1040), line 3b, if the debt is related to nonfarm rental of real property;
• 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 8b, if the debt is farm debt and you are a farmer.

If an applicable 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, this canceled debt is ordinary income and must be reported on the appropriate form shown above.

An applicable entity includes:

• A federal government agency,
• A financial institution,
• A credit union, or
• Any organization a significant trade or business of which is lending 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).

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. However, if the debt is nonrecourse and you did not retain the collateral, you do not have cancellation of debt income. The amount of the canceled debt must be included in income unless one of the exceptions or exclusions described later applies. For more details, see Exceptions and Exclusions, later.

If you owned property that was subject to a recourse debt in excess of the FMV of the property, the lender's foreclosure or repossession of the property is treated as a sale or disposition of the property by you and may result in your realization of gain or loss. If the lender forgives all or part of the amount of the debt in excess of the FMV of the property, the cancellation of the excess debt may result in ordinary income. 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) is determined by the character of the property. The ordinary income from the cancellation of debt (the excess of the canceled debt over the FMV of the property) must be included in your gross income reported on your tax return unless one of the exceptions or exclusions described later applies. For more details, see Exceptions and Exclusions, later.

If you owned property that 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. The character of the gain or loss is determined by the character of the property.

See Publications 523, 544, and 551, and chapter 2 of this publication for more details.

If the abandoned property secures a debt for which you are personally liable (recourse debt) and the debt is canceled, you will realize ordinary income equal to the canceled debt. You must report this income on your tax return unless one of the exceptions or exclusions described later applies. For more details, see Exceptions and Exclusions, later. This income is separate from any amount realized from the abandonment of the property. For more details, see chapter 3.

If the abandoned property secures debt for which you are not personally liable (nonrecourse debt), you may realize gain or loss but will not have cancellation of indebtedness income.

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 treated as dividend income to you. For more information, see Publication 542, Corporations.

If you and another person were jointly and severally liable for a debt that is canceled, each of you may get a Form 1099-C showing the entire amount of the canceled debt. However, you may not have to report that entire amount as income. The amount, if any, you must report depends on all the facts and circumstances, including:

• State law,
• The amount of debt proceeds each person received,
• How much of any interest deduction from the debt was claimed by each person,
• How much of the basis of any co-owned property bought with the debt proceeds was allocated to each co-owner, and
• Whether the canceled debt qualifies for any of the exceptions or exclusions described in this publication.

See Example 3 under Insolvency, later.

There are several exceptions to the inclusion of canceled debt in income. These exceptions apply before the exclusions discussed later and do not require you to reduce your tax attributes.

Generally, you do not have income from canceled debt if the cancellation or forgiveness of the debt is a gift.

Certain student loans provide that all or part of the debt incurred to attend a qualified educational institution will be canceled if the person who received the loan works for a certain period of time in certain professions for any of a broad class of employers.

If your student loan is canceled as the result of this type of provision, the cancellation of this debt is not included in your gross income. To qualify for this treatment, the loan must have been made by:

1. The federal government, a state or local government, or an instrumentality, agency, or subdivision thereof,
2. 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
3. An educational institution (defined later):
   1. Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
   2. 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.

The cancellation of a student loan made by an educational institution because of services you performed for that institution or another organization that provided funds for the loan must be included in the gross income on your tax return unless one of the other exceptions or exclusions described in this publication applies.

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.

Amounts you received after 2008 under any other state loan repayment or loan forgiveness program also are not taxable if the program is intended to increase the availability of health care services in underserved areas or areas with a shortage of health professionals.

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.

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.

• Charitable.
• Educational.
• Fostering national or international amateur sports competition (but only if none of the organization's activities involve providing athletic facilities or equipment).
• Literary.
• Preventing cruelty to children or animals.
• Religious.
• Scientific.
• 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 next.

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.

Any Pay-for-Performance Success Payments that reduce the principal balance of your home mortgage under the Home Affordable Modification Program are not taxable.