The Mortgage Forgiveness Debt Relief Act allows taxpayers to exclude from income up to $2 million ($1 million for married filing separately) of canceled debt on a principal residence. Starting in 2014, the taxpayer will have to include the cancelled debt in their taxable income.
The lender is required to issue a 1099-C, Cancellation of Debt, for the canceled debt. For 2013, the taxpayer must report the canceled debt (shown in Box 2 of the 1099-C) on their tax return with form 982. But the amount will not be included in the taxpayer’s taxable income.
There are two additional situations where the canceled debt will be excluded from taxable income: bankruptcy and insolvency. Cancellation of Debt (COD) Income is not taxable if it is discharged through bankruptcy. In addition, if the taxpayer is insolvent immediately before the cancellation of debt the COD income is not taxable. Insolvency occurs when the taxpayer’s total liabilities exceed the total fair market value of their assets. Assets include the taxpayer’s car, furniture, home, stocks, life insurance and other similar items.
For more information, see IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. View related IRS info page.
This information is provided as an overview of the COD rules. It is recommended that you consult your tax professional to review your particular situation.