- Days left

Settle a Debt Last Year? Here's How You Can Avoid a Big Tax Bill

Lynette Khalfani-Cox photo logoDebt forgiveness – getting a company to write off a debt or let you pay less than you owed on a loan – might seem like a great thing at the time you do it.

What cash-strapped consumer knee-deep in credit card debt wouldn't enjoy the financial relief of settling their debts for perhaps as little as 50 cents on the dollar? And what struggling homeowner who wants to be rid of an unbearable mortgage wouldn't be glad to walk away from that loan – even if it takes a short sale or foreclosure to accomplish the trick?In all these instances, your creditors agree to let you off the hook financially. Even if it wasn't something you wanted -- say, in the case of a forced foreclosure or an auto repossession -- each of those actions results in the lender getting less money than you originally agreed to repay.

And that triggers the prospect of a big tax bill for you.

If you're one of the millions of Americans who got rid of a big debt last year – like a mortgage or credit card bills – through foreclosure, short sale or debt settlement, you've likely already received a 1099-C, a Cancellation of Debt.

By law, any company that writes off $600 or more worth of your debt has to send you – and the IRS – a 1099-C.

So now it's time to use that 1099-C and figure out whether you have to pay taxes on that canceled debt.

"There is no quick fix to financial problems like debt," says Richard Coppa, a Certified Financial Planner and managing director of Wealth Health LLC in Roseland, NJ. "Every short-term financial decision tends to have a long-term ramification and often times it's a tax ramification."

Under normal circumstances, debts that are forgiven result in taxable income to you.

But thanks to the Mortgage Debt Relief Act of 2007, if you got a 1099-C as a result of foreclosure, short sale or a mortgage modification, you've likely dodged a big tax bullet.

According to the IRS, under the Mortgage Debt Relief Act, married people filing a joint return can exclude up to $2 million of forgiven debt on your principal residence from income. (The limit is $1 million for singles or a married person filing a separate return). In other words, if you went through foreclosure, got your mortgage modified or did a short sale, you likely don't owe Uncle Sam a dime.

This special tax relief actually applies to anyone who has forgiven mortgage debt during the tax years 2007 through 2012. But starting in 2013, this tax break goes away.

For now, you can qualify for this tax relief, the IRS says, if you used the debt to buy, build or substantially improve your primary residence.

To claim this tax break, all you need to do is fill out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness.

Don't worry: you need not complete the entire two-page form. If you're just trying to pay zero taxes related to a foreclosure on your primary residence, you only have to fill out lines 1e and 2. For those who had modified mortgages with debt forgiveness, and remained in their homes, complete lines 1e, 2 and 10b.

Then simply attach Form 982 to your 1040 tax return.

How do you know what amounts to fill in? The amount of debt forgiven or canceled will be listed in Box 2 of that 1099-C you received. If all your debt qualifies because it was tied to your principal residence, the amount shown in Box 2 will generally be the amount that you enter on lines 2 and 10b, if applicable, on Form 982.

Pay close attention to the amounts listed on that 1099-C. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed. Again, the amount of debt forgiven will be shown in Box 2; the value listed for your home will be shown in Box 7.

While most homeowners with forgiven debt can likely escape taxes, some mortgage-related debt doesn't get this special treatment.

For example, debt forgiven on second homes, investment or rental property, and mortgage debt resulting from a home equity loan or line of credit that wasn't used to improve your home doesn't qualify for the Mortgage Forgiveness Debt Relief Act and is therefore subject to taxation.

Additionally, other types of forgiven debt don't meet IRS guidelines and will also require you to pay taxes.

These include forgiven debts for business property, consumer loans, credit card debt settled for less than you owed, as well as auto loan debt you no longer have as a result of a car repossession. You may be able to get relief from taxes on these debts, though, if you went through a bankruptcy.

As Coppa puts it: "Outside of that mortgage debt exclusion, if you have a 1099-C for a debt that you didn't wind up paying, you'll likely owe taxes on it."

Forgiven or canceled student loan debt is also generally taxable. But according to the IRS, you may be able to exclude forgiven college debt from your income if, as a condition of your loan(s), you agreed to perform certain work activities for a given time period, and you fulfilled those obligations.

If you have other questions about accounting for forgiven debt, get free tax help from IRS-trained volunteers through the VITA program, which is available nationwide.

Also, be sure to read IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments. It's free when you call the IRS at 800-TAX-FORM (800-829-3676).

Increase your money and finance knowledge from home

Economics 101

Intro to economics. But fun.

View Course »

How to Avoid Financial Scams

Avoid getting duped by financial scams.

View Course »

TurboTax Articles

Cities with the Lowest Tax Rates

The total amount of tax you pay reaches far beyond what you owe the federal government. Depending on where you live, most likely you're required to pay additional taxes, including property and sales tax. The disparity between the amount of tax you pay in a low-tax city and that in a high-tax city can be dramatic. Living in any of these 10 cities could save you a bundle, although the exact amount may fluctuate based on your income and lifestyle choices.

Cities with the Highest Tax Rates

Much ado is made in the press about federal tax brackets, but cities can carry a tax bite of their own. Even if you live in a state that has no income tax, your city may levy a variety of taxes that could eat away the entire benefit of living in an income tax-free state, including property taxes, sales taxes and auto taxes. Consider all the costs before you move to one of these cities, and understand that rates may change based on your family's income level.

Great Ways to Get Charitable Tax Deductions

Generally, when you give money to a charity, you can use the amount of that donation as a deduction on your tax return. However, not all charities qualify as tax-deductible organizations. While there are many types of charities, they must all meet certain criteria to be classified by the IRS as tax-deductible organizations. There are legitimate tax-deductible organizations in many popular categories, such as those listed below.

A Freelancer's Guide to Taxes

Freelancing certainly has its benefits, but it can result in a few complications come tax time. The Internal Revenue Service considers freelancers to be self-employed, so if you earn income as a freelancer you must file your taxes as a business owner. While you can take additional deductions if you are self-employed, you'll also face additional taxes in the form of the self-employment tax. Here are things to consider as a freelancer when filing your taxes.

Tax Deductions for Voluntary Interest Payments on Student Loans

Most taxpayers who pay interest on student loans can take a tax deduction for the expense ? and you can do this regardless of whether you itemize tax deductions on your return. The rules for claiming the deduction are the same whether the interest payments were required or voluntary.

Add a Comment

*0 / 3000 Character Maximum


Filter by:
Paul Young


Are you have any financial problem that you are finding difficult to solve.
We offer a variety of loans to individuals (personal loan) and cooperate bodies at an interest rate of 3% per annul.This is to help you meet your financial obligations, especially with the ongoing global financial crisis. We render out good loan of all kinds in a very fast and easy way, Personal Loan, Home Loan, Student Loan, Business Loan, Investor loan, Car Loan, Debt Consolidation. For further inquiries, please contact us via e-mail ( leonardfergusonfinance01@gmail.com ) Regards. hope to hear from you soonest. all respond to be forward to leonardfergusonfinance01@gmail.com for more information.


January 19 2015 at 10:37 PM Report abuse rate up rate down Reply
Johnny Elvis


Good day everyone, I am Mr Johnny Elvis by name, i am a citizen of new york USA, i have been looking forward for a genuine loan company for the past 2 months and all i got was group of scams who made me to trust them and at the end of the day, they duped me of $7000 without giving anything in return, all my hope was lost, i got confused and frustrated,i find it very difficult to feed my family, i never wanted to have anything to do with loan companies on net again, because i never trusted any loan company again since i was scammed, so i went to borrow some money from a friend, i told him all that happened and he said he can help me, that he knows a loan company that can help me, that he just got a loan from them, he directed me on how to apply for the loan, i did as he told me, i applied, though i never believed but i tried and to my greatest surprise my loan was granted to me within 24 hours, i could not believe, i am happy and rich again and i am thanking God that upon this scams all over the places a genuine company like this still exist, please i advise everyone out there who are in need of loan and can be reliable, trusted and capable of paying back at the due time of funds to contact (eladioloancompany@yahoo.com ) and be free from scams on the internet. they will never disappoint you.

July 26 2014 at 10:03 PM Report abuse rate up rate down Reply