Debt Forgiveness Almost Always Means Additional Income

Debt Forgiveness Almost Always Means Additional Income, but...

Generally, debt forgiven is income added to a taxpayer's return but, if such debt is forgiven  before 2013 and the debt was for a personal residence (qualified), there will be no additional income added to the taxpayer.

There are limits:
The debt must have been used to acquire, construct, or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualified principal residence debt is eligible for the exclusion up to the amount of the old mortgage principal just before the refinancing.

The taxpayer can only exclude up to $2 million  ($1 million if married filing separately).

The taxpayer cannot exclude the forgiveness from income if it was consideration for services or for any reason not directly caused by financial situation or decline in property value.
 
 If the taxpayer continues to own their residence after forgiveness they will need to reduce their basis in the property by the amount of the forgiveness. Make sure the basis is not reduced below zero.

If there is a partial forgiveness,  the exclusion applies only to the extent the amount canceled exceeds the amount of the loan immediately before the cancellation. The remainder, although not qualified under this law; may still be excluded under other Code sections.

Beware, in case of a chapter 11 bankruptcy,  the bankruptcy exclusion must be used instead. They may elect to apply the insolvency exclusion instead of applying the qualified principal residence indebtedness exclusion if they were insolvent immediately before the cancellation,

To qualify for these exclusions the taxpayer needs to provide the proper forms and check the proper boxes.


Tony Dennison Esq. JD LLM
Minneapolis Bankruptcy Lawyer.
505 Highway 169 N. Suite 260
Minneapolis MN 55441
763-404-8800