If you recently had debt forgiven or negotiated down last year, you likely breathed a sigh of relief. However, if you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount as income on your tax return, depending on the circumstances. Before you write a check to the IRS, see if you qualify for one of these exceptions to paying tax on forgiven debt.
- Debts discharged in bankruptcy. If you filed for bankruptcy protection, you do not have to pay tax on the canceled debt.
- Mortgage debt forgiven due to foreclosure. Originally set to expire after the 2012 tax year, the Mortgage Forgiveness Debt Relief Act protects you from having to pay tax on debt forgiven when you lose your home in foreclosure. The deadline has been extended several times, most recently in December 2015 to include the calendar years 20017 through 2016. And in early 2017, a bill to grant another exemption was introduced to Congress.
- Debts canceled when you were insolvent. This is the most common exception, because debt is generally only cancelled when debtors are “insolvent” (i.e. – completely broke). This exclusion only applies up to the amount by which you are insolvent.
- Student loans forgiven after you have worked for a period of time. If your student loans contain a loan forgiveness provision based on service in your profession, do not include the canceled debt as income. In addition, certain federal student loans that were discharged by the U.S. Education Department’s “Defense to Repayment” or “Closed School” discharge process are exempt. These apply to students at Corinthian Colleges and American Career Institutes Inc.
- Forgiven interest that would have been deductible. For example, interest on a business debt. You are not required to pay tax on the portion of the debt due to interest, if you could have deducted the interest if you had paid it. However, if it was interest on a personal credit card- you must pay taxes on all the forgiven debt, including the interest.
- Cancellation of debt as a gift. If the cancellation of debt is a gift, it is not income. Generally, the IRS will believe you if you say the debt payoff was a gift between parties such as family members or friends.
- Business and farm exceptions. You may not have to pay tax on canceled debt if it was in connection with your farm or if the debts were tied to business real estate and were forgiven when you owed more money than the property was worth.
If you have any questions on this topic or are in financial crisis and considering filing for bankruptcy, contact an experienced Miami bankruptcy attorney who can advise you of all of your options. As an experienced CPA as well as a proven bankruptcy lawyer, Timothy Kingcade knows how to help clients take full advantage of the bankruptcy laws to protect their assets and get successful results. Since 1996 Kingcade Garcia McMaken has been helping people from all walks of life build a better tomorrow. Our attorneys’ help thousands of people every year take advantage of their rights under bankruptcy protection to restart, rebuild and recover. The day you hire our firm, we will contact your creditors to stop the harassment. You can also find useful consumer information on the Kingcade Garcia McMaken website at www.miamibankruptcy.com.
Related Resources:
https://www.creditcards.com/credit-card-news/six-exceptions-paying-tax-forgiven-debt-1282.php
https://www.irs.gov/newsroom/home-foreclosure-and-debt-cancellation
