Tax Debt Problems Caused By Cancelled Debt & Foreclosure

Tax Debt: Cancelled Debt & Foreclosure

tax debt problems Lately, Americans have to make tough decisions regarding their finances. In order to just get by, they are going to drastic measures. To make matters worse, many of these difficult choices lead to other problems. Discharging debts may seem like a quick and brutal solution, but it can actually cause tax debt issues. This page will discuss how debt cancellation, foreclosure, and mortgage forgiveness can cause tax debt.

Debt Cancellation

If a commercial lender cancels or forgives a debt, this is considered income by the IRS. Unless it is fraudulent debt caused by identity theft, you will have to report this income by filing a Form 1099-C. When you file your 1040 tax return, you must report this income on Line 21. If the debt that was cancelled was large enough, you will probably have a pretty steep tax debt. There are a few scenarios where debt cancellation is not taxable.

Debt discharged through bankruptcy.
Your total debts are more than the fair market value of your total assets.
Some farm debts are an exception to cancelled debt tax.
Cancelled debts that end in repossession or seizure of collateral are exempt.
Mortgage forgiveness or foreclosure on a primary residence is not taxable.

Foreclosure or Mortgage Relief

As noted above, if you receive mortgage relief or have to foreclose on a primary residence, this will not create a tax debt. This falls under the "Mortgage Forgiveness Debt Relief Act." However, mortgage relief or foreclosure for any other property is taxable.

How to Compute Income from Foreclosure

You will need to use the Form 1099-C to figure out the tax debt from foreclosure. First, you will need to figure out the income made from the cancellation of debt. This is not necessary, if you are reporting a non-recourse loan, since your property or collateral has been repossessed.

Enter the total amount of the debt that was forgiven.
Enter the fair market value of the foreclosed property in box 7.
Subtract line 2 from line 1. If the result is a negative number, just enter zero.

Second, you will need to figure out the gain made from the foreclosure. You will have to do this even if you are reporting cancelled debt from a non-recourse loan. You will never be allowed to claim a loss from a foreclosure on your taxes.

Enter the fair market of the property, or the debt forgiven for non-recourse loans.
Enter your adjusted basis. This is your purchase price plus any money used to improve it.
Subtract line 5 from line 4. Again, the result can only be zero or higher.

It is always best to consult with a tax debt professional to make sure that your cancelled debts are not taxable. The IRS is much more aggressive in collecting a tax debt than commercial lenders are with other types of debt.

If you have a tax debt from cancelling a debt or foreclosing on property, consult a professional. Call (800) 590-4524 now or fill out the form below for a free tax debt consultation on how to take care of your tax debt! We'll only connect you with a tax debt relief company holding at least a B rating with the Better Business Bureau.

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