Wednesday, October 21, 2009

Debt Forgiven but not Forgotten

As we continue down the road toward recession or recovery (depending on one’s point of view), there still continues to be a great deal of people who are having problems paying off their debts. Whether it is a house, car, or some other type of property, the process of paying off one’s debts can become quite stressful especially in a cash strapped economy like the one today. From a tax standpoint, the cancellation of a debt can become a bit tricky, but hopefully after reading this post, you will have a little more insight into how the process works.

According to the IRS via Publication 4681, a debt can include any indebtedness for which you are liable or which is attached to property that you hold. In regards to property, cancellation of debt occurs when foreclosure proceeding occurs on the property, the property is repossessed, the property is returned to the lender, or you abandon the property. When debt is canceled by a federal agency or a financial institution amounting to more than $600, you will receive a Form 1099-C showing the amount for the cancelation in Box 2. Typically the amount is taxable as income.

There are additional exceptions and exclusions of debt that would not be taxable, the most major one being the exclusion for principal residence indebtedness. Taxpayers can now exclude up to $2 million in qualified personal residence indebtedness. Be careful, if you used property to secure a debt and the lender takes all or part of the property to satisfy the debt, the transaction can be treated as a sale which could make you have a taxable gain. Be sure to speak to a professional tax advisor before making any decisions regarding the cancellation of debt.

B. N. S.
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