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Current Year Tax Map
Publication 4681
taxmap/pubs/p4681-001.htm#en_us_publink1000191982

Chapter 1
Canceled Debts(p3)

This chapter discusses the tax treatment of canceled debts.
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General Rules(p3)

rule
Generally, if a debt for which you are personally liable is forgiven or satisfied for less than the full amount owed, the debt is considered canceled in whatever amount if remained unpaid. There are exceptions to this rule, discussed under Exceptions, later. Generally, you must include the canceled amount in your income. However, you may be able to exclude the canceled debt. See Exclusions, later.
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Example.(p3)

John owed $1,000 to Mary. Mary agreed to accept and John paid $400 in satisfaction of the entire debt. John has canceled debt of $600.
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Example.(p3)

Margaret owed $1,000 to Henry. Henry and Margaret agreed that Margaret would provide Henry with services (instead of money) in full satisfaction of the debt. Margaret does not have canceled debt. Instead, she has income from services.
A debt includes any indebtedness: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: 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 canceled debt as ordinary income on:
taxmap/pubs/p4681-001.htm#en_us_publink1000192666

Form 1099–C(p3)

rule
If you receive a Form 1099–C, that means an applicable entity has reported an identifiable event to the IRS regarding a debt you owe. The identifiable event may be an actual cancellation of the debt or it may be an event the applicable entity is required, solely for purposes of reporting to the IRS, to treat as a cancellation of debt. For information on the reasons an applicable entity files Form 1099–C, see Identifiable Event Codes, later.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:
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Identifiable Event Codes(p3)

rule
Box 6 of Form 1099-C may indicate the reason the creditor has filed this form. For 2012, the creditor can choose whether or not to indicate the reason for filing Form 1099–C. See detailed explanations for Codes shown in box 6 below. Also see the chart after explanations for a quick reference guide for Box 6 codes.
Note.Codes A through G and I identify specific occurrences resulting from an actual discharge of indebtedness. However, Code H, Expiration of nonpayment testing period, does not necessarily identify an actual discharge of indebtedness.
Code A — Bankruptcy. Code A is used to identify canceled debt as a result of title 11 bankruptcy case. See Bankruptcy, later.
Code B — Other judicial debt relief.
Code B is used to identify cancellation of debt as a result of receivership, foreclosure, or similar federal or state court proceedings other than bankruptcy.
Code C — Statute of limitations or expiration of deficiency period.
Code C is used to identify cancellation of debt when the statute of limitations for collecting the debt expires, or when the statutory period for filing a claim or beginning a deficiency judgment proceeding expires. In the case of the expiration of a statute of limitations, an identifiable event occurs only if and when your affirmative defense of the statute of limitations is upheld in a final judgment or decision in a judicial proceeding, and the period for appealing the judgment or decision has expired.
Code D — Foreclosure election.
Code D is used to identify cancellation of debt when the creditor elects foreclosure remedies that statutorily end or bar the creditor's right to pursue collection of the debt. This event applies to a mortgage lender or holder who is barred from pursuing debt collection after a power of sale in the mortgage or deed of trust is exercised.
Code E — Debt relief from probate or similar proceeding.
Code E is used to identify cancellation of debt from probate court or similar legal proceeding.
Code F — By agreement.
Code F is used to identify cancellation of debt as a result of an agreement between the creditor and the debtor to cancel the debt at less than full consideration.
Code G — Decision or policy to discontinue collection.
Code G is used to identify cancellation of debt because of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. For purposes of this identifiable event, a defined policy includes both a written policy and the creditor's established business practice.
Code H — Expiration of nonpayment testing period.
Code H is used to indicate that the creditor has not received a payment on the debt during a testing period ending on December 31, 2012. The testing period is a 36-month period increased by the number of months the creditor was prevented from engaging in collection activity by a stay in bankruptcy or similar bar under state or local law. This identifiable event applies only for a creditor that is a financial institution or credit union (and certain of their subsidiaries), the Federal Deposit Insurance Corporation (FDIC). Resolution Trust Corporation (RTC), National Credit Union Administration (NCUA), and other Federal executive agencies.
Expiration of the nonpayment testing period does not necessarily result from an actual discharge of indebtedness.
Code I — Other actual discharge before identifiable event.
Code I is used to identify an actual cancellation of debt that occurs before any of the identifiable events described in codes A through H.
taxmap/pubs/p4681-001.htm#en_us_publink1000192643

Form 1099–C Reference Guide for Box 6 Identifiable Event Codes

ABankruptcy
BOther judicial debt relief
CStatute of limitations or expiration of deficiency period
DForeclosure election
EDebt relief from probate or similar proceeding
FBy agreement
GDecision or policy to discontinue collection
HExpiration of nonpayment testing period
IOther actual discharge before identifiable event
EIC
Even if you did not receive a Form 1099-C, you must report canceled debt as gross income on your tax return unless one of the exceptions or exclusions described later applies.
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Amount of canceled debt.(p4)

rule
The amount in box 2 of Form 1099-C may represent some or all of the debt that has been canceled or is treated as canceled. The amount in box 2 will include principal and may include interest and other nonprincipal amounts (such as fees, penalties, etc.). Unless you meet one of the exceptions or exclusions discussed later, the amount of the debt that has been canceled is ordinary income and must be reported on the appropriate form as discussed earlier.
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Interest included in canceled debt.(p4)

rule
If any interest is included in the amount of discharged 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.
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Persons who each receive a Form 1099-C showing the full amount of debt.(p4)

rule
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:See Example 3 under Insolvency, later.
taxmap/pubs/p4681-001.htm#en_us_publink1000192653

Discounts and loan modifications(p4)

rule
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 the 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.
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Sales or other dispositions (such as foreclosures and repossessions)(p4)

rule
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.
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Abandonments(p4)

rule
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.
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Stockholder debt(p4)

rule
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. For more information, see Publication 542, Corporations.
taxmap/pubs/p4681-001.htm#en_us_publink1000192015

Exceptions(p4)

rule
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.
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Gifts, Bequests, Devises, and Inheritances(p4)

rule
In most cases, you do not have income from canceled debt if the cancellation or forgiveness of the debt is a gift, bequest, devise, or inheritance.
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Student Loans(p4)

rule
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.
taxmap/pubs/p4681-001.htm#en_us_publink1000192018

Exception.(p4)

rule
Generally, 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.
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Education loan repayment assistance.(p5)

rule
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. The program must be intended to increase the availability of health care services in underserved areas or areas with a shortage of health professionals.
taxmap/pubs/p4681-001.htm#en_us_publink1000192020

Educational institution.(p5)

rule
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.
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Section 501(c)(3) organization.(p5)

rule
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.
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Deductible Debt(p5)

rule
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.
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Example.(p5)

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.
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Price Reduced After Purchase(p5)

rule
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.
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Home Affordable Modification Program(p5)

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