Especially during an economic downturn, many taxpayers may find themselves being forgiven debt. For example, if your home is foreclosed on and you agree to a short sale in which the bank will sell the home and will consider whatever price it gets to cover what you owe, the difference between the selling price and your mortgage balance is forgiven debt. Forgiven debt is reported on IRS Form 1099-C and may have a significant impact on your taxes.
Filing an Amended Return
In general, the IRS treats canceled debt as income to you. For example, if you owed $10,000, your net worth was negative $10,000. If that debt is canceled, and you now owe nothing, your new net worth is $0, an increase in $10,000. Therefore, the IRS considers the cancellation of debt to be a taxable event. If you receive the Form 1099-C after you have already filed your tax return for the year, you must file an amended return to make the necessary corrections to your tax return.
Form 1040X is form used to amend your income tax return. In Part I, adjust your taxable income to include the amount of the debt forgiven as part of your taxable income. For example, if your credit card company forgave $5,000 of your credit card debt in an effort to help you pay off your bills, you would have to increase your taxable income by $5,000 on your Form 1040X. In Part III, explain the reason that the taxable income increase is that you received a Form 1099-C after you filed your original return.
Special Treatment for Home Mortgage Debt Forgiveness
Internal Revenue Code Section 108 contains a special provision that applies to home mortgage debt forgiven before Jan. 1, 2013. Under this provision, mortgage debt forgiveness on a principal residence is not treated as taxable income. Instead, the taxpayer must reduce the basis in the home by the amount of debt forgiven, but not below zero. For example, if a taxpayer purchased her primary residence for $100,000 and has $20,000 of mortgage debt forgiven, she would not have to include the $20,000 of debt forgiveness as taxable income. Instead, she would decrease her basis in her home from $100,00 to $80,000, which would result in a larger taxable gain when the home is sold.
You should not receive a Form 1099-C for debt that was fraudulently accrued in your name. For example, if you had your identity stolen and the thief ran up charges on your credit card without your knowledge, and later those charges were forgiven due to the identity theft, you should not receive a Form 1099-C. If you do, contact the issuer to have the form retracted or a corrected statement issued showing no canceled debt.
- IRS.Gov: Form 1099-C Instructions
- IRS.gov: Form 1040X Instructions
- Legal Information Intitute: 26 USC § 108 - Income from Discharge of Indebtedness
- Internal Revenue Service. "About Form 1099-C." Accessed Jan. 17, 2020.
- Internal Revenue Service. "Canceled Debt - Is It Taxable or Not?" Accessed Jan. 17, 2020.
- Internal Revenue Service. "2020 Instructions for Forms 1099-A & 1099-C." Accessed Jan. 17, 2020.
- Internal Revenue Service. "2020 Form 1099-C." Accessed Jan. 17, 2019.
- Internal Revenue Service. Form 1099-C. Accessed Feb. 3 2020.
- Internal Revenue Service. "How to Prepare Your Tax Return for Mailing." Accessed Jan. 17, 2020.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."