If you owe a debt to someone and he or she forgives it, that amount could be taxable.

The Mortgage Debt Relief Act of 2007 lets taxpayers exclude income from the discharge of debt on their primary residence. Forgiven mortgage debt from a foreclosure and reduced debt through mortgage restriction both qualify for relief.

If your debt was forgiven between 2007 and 2014, up to $2 million of it is eligible for this exclusion. If the discharge of debt is not directly associated with the home’s declining value or the taxpayers financial situation, the exclusion does not apply.

That said, here are a few key points regarding the cancellation of debt.

Cancellation of Debt: What is it?

When you borrow money from a lender, you are not required to include the income from that loan for tax purposes because you are obligated to repay it. But if a lender forgives or cancels that debt, you could be responsible for reporting it. The lender will use a 1099-C form to report the amount of canceled debt to you and the IRS.

Example: If you borrow $20,000 and default on the loan after paying the lender back $5,000 of it, there will be a cancelation debt of $15,000 that could be taxable.

Cancellation of Debt Income: Is it always taxable?

In some circumstances, cancellation of debt income is not taxable. This happens if:

  • The debt is discharged through bankruptcy
  • The debt is canceled when you are insolvent
  • The debt is incurred while you are operating a farm
  • The debt is associated with a non-recourse loan

For more information about where you stand, contact a real estate attorney today.

Stephen K. Hachey, a Florida real estate attorney, can help your wade through this process and determine a positive solution. Contact him at 813-549-0096.

The opinions in this post are solely those of the author. The author takes full responsibility for the content. Like all blog posts, this is offered for general information purposes and does not constitute legal advice.