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What Does and Does Not Constitute Cancellation of Debt (C.O.D.) Income

September 16, 2022

Below please find some information related to Cancellation of Debt (C.O.D.) income.

In general, if you have C.O.D. income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable, and you must report the canceled debt on your tax return for the year the cancellation occurs. The canceled debt isn't taxable, however, if the law specifically allows you to exclude it from gross income.

After a debt is cancelled and the amount forgiven or canceled is $600 or more, the lender must issue and send to you and to the IRS a Form 1099-C, Cancellation of Debt, showing the amount of debt canceled. Even though the creditor has issued Form 1099-C, you may be able to claim an exclusion from income for the canceled debt.

In general, you must report any taxable amount of a canceled debt as ordinary income from the cancellation of debt on Form 1040 / U.S. Individual Income Tax Return, 1040-SR / U.S. Tax Return for Seniors or Form 1040-NR / U.S. Nonresident Alien Income Tax Return as "other income" if the debt is a nonbusiness debt, or on an applicable schedule if the debt is a business debt.

Exclusions from Gross Income. C.O.D. income is not always taxable. The most common situations in which cancelled debt does not result in taxable income include the following:

  • The debt has been discharged through a bankruptcy proceeding under Title 11 (commonly known as the Chapter 11 bankruptcy);

  • Insolvency (your total debts exceed your total assets);

  • The debt is due to a qualified farm expense or farm property (“qualified farm indebtedness”)

  • The debt is due to certain real property used in a trade or business (“qualified real property business debt): and

  • Qualified principal residence indebtedness before January 1, 2026

  • Qualified Paycheck Protection Program Loan forgiveness

When canceled debt from gross income falls under one of the exclusions from above, the debtor may be required to reduce tax attributes, such as the basis of property. The reduction of attributes must be reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach with your federal income tax return. If you do not reduce attributes, the IRS may take the position that you are taxable on the C.O.D. income.

Other Exceptions may apply to student/education loans, disaster victims, gifts, bequests/devises, inheritances, general welfare payments, and deductible payments.

Mortgage debt forgiveness. For a limited period of time, certain mortgage debt that is discharged by the lender is excludable from C.O.D. income and therefore does not result in taxable income to homeowners. This is generally referred to as "qualified principal residence debt." The cancellation of qualifying mortgage debt is excludable from income if it is incurred with respect to the taxpayer's principal residence for "acquisition" debt forgiven before January 1, 2026. Acquisition debt is indebtedness secured by the residence and incurred in the acquisition, construction or substantial improvement of the residence. The exclusion is limited to $750,000 ($375,000 for married taxpayers filing separately).

Certain debt used to refinance the debt is also eligible. Debt forgiven on a second home or rental property does not qualify.

Credit card and car loan debt. Noticeably absent from the specific exceptions to C.O.D. income are two of the biggest consumer debt items: credit cards and car loans. Credit card debt or an unpaid debt on a car loan that is forgiven by the lender is includable in gross income, unless the debtor is bankrupt or insolvent. The lender will report the amount of forgiven debt on Form 1099-C.

If you had debt discharged from income that does, or does not, qualify for an exception, you must include the amount of cancelled debt in your gross income on your tax return.


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