Cancellation of Debt as Income

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On behalf of Silver Tax Group posted in IRS Tax Audits on Thursday, March 23, 2017.

It is important to remember that cancellation of a debt does not mean that your financial worries will come to an end. Any Michigan taxpayer who has part or all of their debt cancelled may nevertheless need to report this amount as income. When lenders cancel $600 or more of your debt, you should then receive a Form 1099-C providing the amount of the debt cancellation.

Exclusion to cancelled debt

The IRS does provide exclusions to this cancelled debt as income. For example, there are exclusions that apply to cancellation of mortgage debt on the main home the taxpayer owns. However, such exclusion only applies to loans used in buying, building or improving upon that individual’s primary property.

A loan modification may also result in savings which technically becomes income to the taxpayer. However, during such loan workouts, the IRS still may allow exclusion of that portion of the debt cancellation as reportable income. The same exclusion may also apply regarding debt savings during refinancing of a mortgage. But just as with cancellation of mortgage debt, this again only involves purchasing, building or improving upon one’s primary property.

There are many forms of cancelled debt that do not receive any exclusion as reportable income for tax purposes. This can include cancellation concerning rental property, business property, credit cards and car loans.

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The rules concerning cancellation of debt can prove to be complex. Mistakes made when figuring out whether exclusion occurs can result in scrutiny of your tax forms. Therefore, it is a good idea to discuss your legal options when in doubt about the legitimacy of any exclusionary claim.

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