For use in preparing 2008 Returns
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 this as “canceled debt” whether it is canceled or forgiven. However, under certain circumstances, you may not have to include canceled debt from income you may also be required to reduce “tax attributes.” Reduction of tax attributes is discussed in more 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 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 debt 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 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 is business or investment property, but not if it is personal use property, such as your residence.
This publication discusses the general rule requiring canceled debt to be included in income, exceptions to the general rule, exclusions from the general rule, and the ordering rules for reduction of tax attributes by reason of the exclusion of canceled debt from income. This publication also discusses the tax treatment resulting from foreclosures, repossessions, and abandonments and provides detailed examples with filled-in forms.