Tax Implications Of Canceled Debt

The IRS is very picky when it comes to income taxes and in most cases, except for those outlined below and reiterated in a recent release, a cancellation of debt is considered income for the debtor. Let’s say you owed $10,000 to a bank, the bank cancels it, essentially the bank gave you $10,000 for nothing right? That’s considered income unless it’s one of the conditions below:

Bankruptcy: If you go through bankruptcy and the debt is canceled then it’s not considered taxable income.

Insolvency: If you are insolvent, if your total debts are more than the fair market value of your total assets, then it’s not taxable. This is hard to prove and very complicated so you’ll need a tax professional to help you prove this.

Certain farm debts: I won’t go into this one since it doesn’t apply, search for it if it does.

Non-recourse loans: According to the IRS, this is “a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default.”

The IRS release contains more information and is definitely worth reading.