Cancelled debt CPAs understand the tax rules for reporting cancellation of debt. But most Folks who call me don’t. Plus they’re often nervous because the potential tax due on Form 1099-C is roughly 25-30% of the amount in Box 2. Yikes. And they’re intimidated by the Form 982 instructions and IRS Publication 4681.
So I’ll present a primer on cancelled debt and discuss the most frequent questions I’m asked about Form 1099-C, Cancellation of Debt, and, Form 982, Reduction of Tax Attributes.
The Form 982 instructions and IRS Publication 4681 cover more tax reporting than you need
Like most IRS tax forms, Form 982, Reduction of Tax Attributes, covers a variety of canceled debt circumstances. That means most of the IRS rules don’t apply to your specific situation. One client defined the terminology used in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, as IRS double speak. Cute but true.
What is Form 1099-C, Cancellation of Debt?
It’s a form that reports a lender writing off some or all of your debt. You get a copy. The IRS gets a copy. Generally speaking, the amount of cancelled debt in Box 2 of Form 1099-C becomes taxable income on your business and/or personal income tax returns unless you can exclude it through one or more of the Form 982 provisions.
Does all Discharge of Indebtedness taxable?
No there are exceptions. Cancelled debt via a gift isn’t taxable (but do the research to ensure this exception applies to you). But, if you receive a IRS Form 1099-C, Cancellation of Debt, it’s almost always taxable.
IRS Insolvency on Form 982
Folks call me the Insolvency CPA because one of my posts ranked well in Google. But Insolvency is only one exclusion on Form 982. Sometimes you can use multiple exclusions.
Types of situations that generate Form 1099-C, Cancellation of Debt
- Car repossession.
- Primary residence foreclosures.
- Primary residence loan modifications.
- Primary residence short sales.
- Rental property foreclosures.
- Rental property loan modifications.
- Rental property short sales.
- Settling credit card debt for less than the full amount due.
- Student loan debt. For example the lender’s will write off the student loan if you become disabled. But you still have to pay the taxes on it.
Does Form 1099-C mean the bank can’t still try to collect on my debt?
Sometimes they can still try to collect from you.
I didn’t get a Form 1099-C
Form 1099-C issuance seems capricious. But I’ve had multiple cases where the IRS got their copy of Form 1099-C and the Client didn’t. Probably because of a bad address issue. They called me after receiving the infamous IRS Notice CP2000 “proposing” they pay tax on the entire amount in Box 2. I’d check with the IRS if you expected a Form 1099-C. Amending a prior return to include Form 982, Reduction of Tax Attributes, is a common scenario.
“There’s not always a free ride with the discharge of indebtedness tax reporting rules. Sometimes Form 982 just delays taxes until you sell other property. Please read below for an example. “
– Gary Bode, discharge of indebtedness CPA
What’s the Reduction of Tax Attributes section of Form 982?
Let’s say the Bank adjusted your mortgage debt with a loan modification. The first hurdle, excluding the $500,000 from taxable income on Form 982, is straight forward. But Form 982 requires you reduce the basis of your assets. That means you would incur more taxable gain if you sell them.
Here’s the non Form 982 sale scenario. You paid $1,500,000 for the home. So if sold it for $2,000,000 there would be a $500,000 capital gain. Since there’s a primary capital gain exclusion for a primary residence you have no tax liability for the $500,000. Ever. A truly free ride.
Here’s the sales scenario with the Form 982. Your basis (purchase price) of home drops to $1M ($1,500,000 purchase price less the $500,000 of tax attribute reduction from Form 982. You sell it eventually for the same $2M. You have $1M of gain. Less the $500,000 primary home capital gains exclusion equals $500,000. Ouch you’re paying capital gains on the $500,000 you avoided initially with Form 982.
Moral of the story:
- Planning can sometimes make Form 982 a free ride without raising IRS red flags.
- Keep track of you your reduced basis and factor the tax in when you plan to sell the Form 982 affected asset.
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