You must fill out IRS Form 982 if you have been released of an obligation to pay a financial obligation. Such discharge must be reported to the tax authority, as it may qualify as income, and be therefore subject to income tax.
The purpose of IRS Form 982 is to report "discharge of indebtedness". In other words, you must file Form 982 if you have any financial obligation that has been in part or entirely forgiven.
When a debt on an asset is forgiven, the net effect on the borrower's personal worth is much like income realized in the form of cash. If you have bought a car with a $10,000 loan for instance and, for some reason, $2,000 of your outstanding debt is forgiven by the lender, you will be $2,000 richer. This is in fact as good as having received a $2,000 cash grant, and under most conditions, is even more advantageous than a cash handout of the same size. Considering the reduction in the interest that would otherwise have accrued, this forgiveness will likely save you more than $2,000.
When to File
Form 982 should be filed with your income tax return. The deadline for filing this form is April 15 of the year after the debt has been forgiven unless you have obtained an extension from the IRS to file your taxes late.
Before you file Form 982, prepare all the information required. This includes the type of debt that was discharged and the portion of the debt discharge that was not reflected in the reduced basis of your assets. Under certain conditions, you can report debt forgiveness in your ordinary income by reducing the cost basis of the property the debt is attached to. If, for instance, you have a mortgage for $200,000 and $20,000 of this mortgage loan is forgiven by the bank, you also can reflect this by reducing the cost of your home by $20,000. Refer to the instructions on Form 982 for an explanation of when you can account for debt reduction by reducing the cost basis of the underlying assets. Also, check out the flowchart on Page 2 of the Form (see References) to see if you have to fill out the entire form. Some individuals will have to fill out only a few lines on the form.