Publication 4681

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Canceled Debts, Foreclosures, Repossessions, and Abandonments

Overview

This publication explains the federal tax treatment of canceled debts, foreclosures, repossessions, and abandonments.

Generally, if you owe a debt to someone else and they cancel or forgive that debt, you are treated for income tax purposes as having income and may have to pay tax on this income. This publication refers to debt that is canceled or forgiven as “canceled debt.” However, under certain circumstances, you may not have to include canceled debt in income. If you do exclude canceled debt from income, you may also be required to reduce your “tax attributes.” Reduction of tax attributes is discussed in detail later in this publication.

If you have property that is security for a debt and that property is taken by the lender in full or partial satisfaction of your debt, you will be treated as having sold that property and may have a gain or loss as a result. For this purpose, it does not matter whether the lender took the property through foreclosure, repossession, a voluntary conveyance by you to the lender, or your abandonment of the property. If the lender cancels recourse debt (defined in chapter 1) in excess of the fair market value (FMV) of the property taken by the lender, the excess of the canceled debt over the FMV of the property may have to be treated by you as ordinary income from the cancellation of debt (COD) in addition to any taxable gain that you may have had from being treated as having sold the property.

If you are treated as having sold the property, any gain you have will generally have to be reported on your income tax return. If you have a loss, you may be entitled to deduct the loss if the property that was returned to the lender was business or investment property, but not if it was personal use property, such as your home.

This publication discusses the general rule requiring canceled debt to be included in income, exceptions to the general rule, exclusions of certain types of canceled debt from income, and the rules for reduction of tax attributes because of the exclusion of canceled debt from income. This publication also discusses the tax treatment of foreclosures, repossessions, and abandonments and provides detailed examples with filled-in forms.

How To Use This Publication

The sections of this publication that will apply to you depend on the type of debt canceled, the tax attributes you have, and whether or not you continue to own the property that was subject to the debt. Some examples illustrating common circumstances are provided in the following paragraphs to help guide you through this publication. These examples do not cover every canceled debt situation, but are intended to provide general guidance for the most common situations.

Nonbusiness credit card debt cancellation. If you had a nonbusiness credit card debt canceled, you may be able to exclude the canceled debt from income if the cancellation occurred in a title 11 bankruptcy case, if you were insolvent immediately before the cancellation, or if you were affected by the Midwestern disasters. You should read Bankruptcy, Insolvency, or Qualified Midwestern Disaster Area Indebtedness under Exclusions in chapter 1 to see if you can exclude the canceled debt from income under one of those provisions. If you can exclude part or all of the canceled debt from income, you should also read Bankruptcy, Insolvency, and Qualified Midwestern Disaster Area Indebtedness under Reduction of Tax Attributes in chapter 1.

Personal vehicle repossession. If you had a personal vehicle repossessed during the year, you will need to determine your gain or nondeductible loss on the repossession. This is explained in chapter 2 . If the lender also canceled all or part of the remaining amount of the loan, you may be able to exclude the canceled debt from income if the cancellation occurred in a title 11 bankruptcy case, if you were insolvent immediately before the cancellation, or if you were affected by the Midwestern disasters. You should read Bankruptcy, Insolvency, or Qualified Midwestern Disaster Area Indebtedness under Exclusions in chapter 1 to see if you can exclude the canceled debt from income under one of those provisions. If you can exclude part or all of the canceled debt from income, you should also read Bankruptcy, Insolvency, and Qualified Midwestern Disaster Area Indebtedness under Reduction of Tax Attributes in chapter 1.

Main home foreclosure or abandonment. If a lender foreclosed on your main home during the year, you will need to determine your gain or nondeductible loss on the foreclosure. Foreclosures are explained in chapter 2 and abandonments are explained in chapter 3. If the lender also canceled all or part of the remaining amount on the mortgage loan and you were personally liable for the debt, you should also read Qualified Principal Residence Indebtedness (QPRI) under Exclusions in chapter 1 to see if you can exclude part or all of the canceled debt from income. Detailed Examples 2 and 3 in chapter 4 use filled-in forms to help explain these provisions.

Main home loan modification (workout agreement). If a lender agrees to a mortgage loan modification (a “workout”) that includes a reduction in the principal balance of the loan, you should read Qualified Principal Residence Indebtedness under Exclusions in chapter 1 to see if you can exclude part or all of the canceled debt from income. If you can exclude part or all of the canceled debt from income, you should also read Qualified Principal Residence Indebtedness under Reduction of Tax Attributes in chapter 1. Detailed Example 1 in chapter 4 uses filled-in forms to help explain the tax implications of a mortgage workout scenario.


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