Cancellation of Debt is defined by the IRS (Internal Revenue Service) as money that is borrowed from a commercial lender and then later the lender forgives or cancels the debt. This "forgiven amount" may be taxable in certain situations. In these situations, the forgiven amount is considered income and must be reported to the IRS on a 1099-C form.
Non-Taxable Cancellation of Debt
There are several situations where cancellation of debt is not taxable and therefore doesn't have to be reported. Bankruptcy is a situation where your debt is discharged and is not considered taxable. Non-recourse loans are also not taxable and aren't considered to be a cancellation of debt. However, there may still be tax consequences that are applicable to this type of loan. A non-recourse loan is a loan in which the property financed or the property used as collateral is repossessed if the loan goes into default. If you acquire debt from the operation of a farm, more than half your income from the past three years came from farming, and the loan is owed to an individual or agency that is regularly involved in lending, then generally speaking, your cancellation of debt is not taxable.
Taxable Cancellation of Debt
In any other situation of debt, your cancellation of debt would be taxable, and therefore, would need to be reported to the IRS on a 1099-C form. You figure your cancellation of debt from foreclosure on the 1099-C form by entering the total amount of debt prior to foreclosure on line 1. Then enter the fair market value of the property from form 1099-C, box 7 on line 2. Next, subtract line 2 from line 1 and enter the amount on line 3. If the amount is less than zero, enter zero on line 3.
Internal Revenue Service
If you have any questions regarding cancellation of debt, you can contact your local IRS office. This information can be found at the IRS website.