The U.S. Internal Revenue Service (IRS) describes debt cancellation as the portion of a debt that is forgiven or cancelled by a creditor. The cancelled debt does not evaporate into the ether. Instead it becomes a part of what the IRS calls "taxable income"--a dirty word for most taxpayers. All items considered taxable income, including the amount of the debt cancellation, is taxed according to the IRS tax laws. However there are exceptions, as well as some information that you should be aware of.
Types of Taxable but Cancelled Debt
The debt cancellation from most debt transactions is taxable as income. This includes debt cancellation of mortgages, credit card balances, auto loans and most any other debt which you no longer have an obligation to pay back.
Exceptions
There are a few exceptions to the debt cancellation income rule. First, if any lender has no choice but to foreclose or take back the property, the debt left over after sale of the property is non-taxable. Cancelled farm debt is not taxable if over half your income over last 3 years was from farming and your debt is through a lender that does only that. Also, debt cancelled because of a discharged, or completed, bankruptcy process is not taxable.
A Capital Gain
Consult a tax law professional before claiming these debts as non-taxable. Although they may be excluded from debt cancellation income, you may have to pay a gains tax on the income. This usually happens in foreclosures where the foreclosure sale is considered a regular sale. If the cancelled debt equals more than $250,000 for a single person, $500,000 for a married couple, and the home was your primary residence, then the amount over these stated limits is taxable as a capital gain. If the home wasn't a primary residence, you are responsible for all of the cancelled debt as it is a capital gain.
New Law
In 2008, a new law was created to help homeowners strapped as a result of the subprime mortgage crisis. The Mortgage Forgiveness Debt Relief Act of 2007 allows homeowners to cancel up to $2 million dollars for couples and $1 million dollars for singles without tax implications. The home must be your primary residence. Any debt cancelled as a result of "restructuring" a mortgage and foreclosures qualify for this debt relief. The amount of debt cancelled also has to be a result of the decrease in your home's value. This law remains in force until 2012.
Debt Be Gone
The advantage of debt cancellation, despite the tax implication, is that the debtor is no longer responsible for a debt that they cannot pay. For many this is more important than saving a few dollars on the tax bill. In fact, the capital gain if any may be reduced by the taxpayer's income, so the dreaded tax bill may not be a worry at all.
0 comments:
Post a Comment