IRS & Debt Cancellation

Creditors no longer require payment of cancelled debt.
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The Internal Revenue Service debt cancellation rules apply to debt for which you are personally liable. After cancelling your debt, the creditor will report the action to you and the IRS using IRS Form 1099-C, Cancellation of Debt. The IRS narrowly defines “cancelled debt” for tax-reporting purposes. The rules change if property used to secure the debt is returned to the creditor. If your creditor cancels, discharges or forgives your debt, you might have to report the amount as income when you file your taxes.

Debt and Income

The IRS does not consider the loan you receive to buy a house or car as taxable income since you agree at the time to repay the creditor. Once your debt is cancelled and you are no longer liable for the debt, the amount you received from the creditor is reportable as taxable income. The amount of the cancelled debt you report as income for a debt you owe “jointly and severally” with another person depends on state law and other considerations. Your cancelled debt might be reportable as dividend income if you are a shareholder in a corporation that cancels your debt.

Debt Cancellation

Creditors cancel debt because of foreclosure on a home or vehicle repossession. Your creditor may cancel your debt in whole or in part if it is uncollectable or if you return or abandon the property that secures the debt. Cancelled debt also can result from a loan modification on your principal residence. If the sale of a repossessed car or foreclosed home does not cover the total loan amount and the creditor forgives the balance, the cancelled debt is considered income. If the creditor continues collection efforts after sending you Form 1099-C, debt cancellation has not occurred, and there is no taxable income from debt cancellation to report.

Exceptions and Exclusions

The IRS provides exceptions and exclusions from reporting some cancelled debt as gross income. Exceptions include certain student loans and bequests, gifts or other funds excluded from inclusion as income. Exclusions include debts discharged through Title II bankruptcy, qualified principal residence debt and insolvency. Some exceptions and exclusions apply to business debt. Report excluded canceled debt on IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment). Attach Form 982 to your income tax return when filing.

Reporting Debt Cancellation Income

The IRS requires you to report taxable cancellation income even if the creditor does not send you a Form 1099-C. The amount of cancelled debt is reported as gross income on Form 1040 or Form 1040NR when you file your annual income tax return. Instructions for identifying and reporting taxable debt cancellation income are included in the IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments (for Individuals).


You might have to report a gain or loss if the creditor takes the property that secures your debt, such as might occur with abandonment or repossession. Whether the property satisfies all or part of the debt, the IRS will treat the occurrence as if you sold the property. The issue of reportable gain or loss from the sale of your property, which is covered in IRS Publication 544 Sales and Other Dispositions of Assets, is separate from debt cancellation reporting requirements.

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