If a lender cancels part or all of a debt, a taxpayer must generally consider this as income. However, the law allows an exclusion that may apply to homeowners who had their mortgage debt canceled in 2016.
10 Tips About Debt Cancellation
1. Main Home
If the canceled debt was a loan on a taxpayer’s main home, they may be able to exclude the canceled amount from their income.
They must have used the loan to buy, build, or substantially improve their main home to qualify. Their main home must also secure the mortgage.
2. Loan Modification
If a taxpayer’s lender canceled or reduced part of their mortgage balance through a loan modification or ‘workout,’ the taxpayer may be able to exclude that amount from their income.
They may also be able to exclude debt discharged as part of the Home Affordable Modification Program (HAMP). The exclusion may also apply to the amount of debt canceled in a foreclosure.
3. Refinanced Mortgage
The exclusion may apply to amounts canceled on a refinanced mortgage. This applies only if the taxpayer used proceeds from the refinancing to buy, build, or substantially improve their main home, and only up to the amount of the old mortgage principal just before refinancing.
Amounts used for other purposes do not qualify.
4. Other Canceled Debt
Other types of canceled debt—such as second homes, rental and business property, credit card debt, or car loans—do not qualify for this special exclusion.
However, there are other rules that may allow those types of canceled debts to be nontaxable.
5. Form 1099-C
If a lender reduced or canceled at least $600 of a taxpayer’s debt, the taxpayer should receive Form 1099-C, Cancellation of Debt, by February 1.
This form shows the amount of canceled debt and other information.
6. Form 982
If a taxpayer qualifies, they must report the excluded debt on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness.
They should file the form with their income tax return.
7. IRS.gov Tool
Taxpayers should use the Interactive Tax Assistant tool — Do I Have Cancellation of Debt Income on My Personal Residence? — available on IRS.gov to find out if their canceled mortgage debt is taxable.
8. Exclusion Extended
The law that authorized the exclusion of canceled debt from income was extended through December 31, 2016.
9. IRS Free File
IRS e-file is the fastest, safest, and easiest way to file.
Taxpayers can use IRS Free File to e-file their tax return for free:
- If they earned $64,000 or less, they can use brand-name tax software.
The software does the math and completes the correct forms for them. - If they earned more than $64,000, they can use Free File Fillable Forms.
This option uses electronic versions of IRS paper forms and is best for those accustomed to doing their own taxes.
Free File is available only on IRS.gov/freefile.
10. More Information
For more on this topic, see Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.
Frequently Asked Questions
What types of canceled debt can be excluded from income?
Canceled debt on a primary residence may be excluded from income if the loan was used to buy, build, or significantly improve the home. However, canceled debts related to second homes, rental property, credit cards, or car loans generally do not qualify for this specific exclusion.
Does canceled mortgage debt from refinancing qualify for the exclusion?
Yes, but only if the refinanced funds were used for the original home’s purchase, construction, or improvement, and only up to the principal balance of the old mortgage. Funds used for other purposes do not qualify.
What IRS forms are required to report excluded canceled debt?
If debt of $600 or more was canceled, the taxpayer should receive Form 1099-C. To report the exclusion, they must complete and submit Form 982 with their tax return.
Can loan modifications under government programs be excluded from income?
Yes. Debt canceled through a loan modification or under programs like HAMP may qualify for exclusion from income, as long as the loan is secured by the taxpayer’s main home.
How can I determine if my canceled mortgage debt is taxable?
The IRS offers the Interactive Tax Assistant tool on IRS.gov, which helps taxpayers determine whether their canceled debt is taxable or excluded from income under current laws.