Home Foreclosure and Debt Cancellation: Income Tax Effects
Glenn Tyndall, CPA
What is Cancellation of Debt?
Cancelled debt is any money borrowed from a commercial lender that the lender later forgives such that you are no longer obligated to repay the debt. This cancelled debt may be included in income for tax purposes and the lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.
- You borrow $8,000 and pay back $4,000.
- You default on the remaining $4,000 and the lender is unable to collect.
- There is a cancellation of debt of $4,000, which generally is taxable income to you.
- You and the IRS receive IRS Form 1099-C, Cancellation of Debt, reporting $4,000 of cancelled debt.
Is Cancellation of Debt income always taxable?
Cancelled debt is not always taxable. The most common reasons for excluded cancelled debt from gross income are:
- Bankruptcy – Debts discharged in bankruptcy are not taxable income.
- Insolvency – You are insolvent when your total debts are more than the fair market value of your total assets.
- Certain farm debts – Cancelled debt used directly in operation of a farm is not included in taxable income if more than half your income from the prior three years was from farming and the loan was owed to a person or agency regularly engaged in lending.
- Non-recourse loans – A non-recourse loan is a loan for which the lender’s only remedy in the event 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.
I lost my home through foreclosure. What are the tax consequences?
There are two possible consequences you must consider:
- Taxable cancellation of debt income. (Note: Cancellation of debt income is not taxable in the case of non-recourse loans.)
- A reportable gain from the disposition of the home because foreclosures are treated like sales for tax purposes, although you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) of gain from income.
I lost money on the foreclosure of my home. Can I claim a loss on my tax return?
No. Losses from the sale or foreclosure are not deductible.