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Cancellation of debt income in bankruptcy, insolvency and foreclosure

Simply put, "cancellation of debt income" refers to any obligation to repay a lender that is forgiven, cancelled or discharged for less than what was originally owed. Generally speaking, most cancellation of debt income is taxable. However, there are some notable exceptions to this rule.
 
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    February 06, 2014 /24-7PressRelease/ -- Cancellation of debt income in bankruptcy, insolvency and foreclosure

Article provided by Levitt & Slafkes, P.C.
Visit us at http://www.levittslafkes.com/

All Americans have an obligation to pay taxes on the income they acquire during a given year. When preparing a tax return, however, it is important to understand that the Internal Revenue Service's definition of "income" includes far more than just wages earned from employment. For example, the IRS requires taxpayers to claim cancelled debts as income.

Simply put, "cancellation of debt income" refers to any obligation to repay a lender that is forgiven, cancelled or discharged for less than what was originally owed. For example, if a person borrowed $10,000, repaid $4,000 of it and the lender agreed not to attempt to collect the rest, that person would have $6,000 in cancellation of debt income.

Generally speaking, most cancellation of debt income is taxable. However, there are some notable exceptions to this rule. The two most common exceptions are discussed below.

Cancelled debt in bankruptcy and insolvency

Debt that is cancelled as part of a bankruptcy case (including Chapter 7, Chapter 11 and Chapter 13 bankruptcy) does not count as taxable income. This applies both to unsecured debts like credit card debt and medical bills, along with secured debts in which property is repossessed to satisfy the loan.

In addition, debt that is cancelled immediately before the borrower becomes insolvent is also excluded from taxable income. "Insolvency" means that a person's liabilities are greater than the value of all of his or her assets. It is important to note, however, that depending on the extent of the insolvency, it is possible that not all cancellation of debt income will be excludable.

Cancelled debt relating to a primary residence

As part of the financial crisis, many homeowners have found themselves with mortgage payments they cannot afford or homes that are worth far less than the amount owed on the mortgage. As a result, many have lost their homes to foreclosure, sold them in a short sale or had their mortgage debt reduced in a loan modification.

Cancelled mortgage debt qualifies as taxable income. A law which excluded certain mortgage related debt from being considered taxable income, called the Mortgage Forgiveness Debt Relief Act of 2007, expired on December 31, 2013.

There is still a chance that Congress may reenact the law.

Working with an attorney

This is just a brief overview of some of the rules pertaining to cancellation of debt income. If you have questions about how your cancelled debt will be treated at tax time, it is best to discuss them with a qualified professional. If you are struggling with debts you cannot afford to pay, an experienced bankruptcy attorney can help you work with your creditors to discharge your debts and move forward with your life.



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