If you’re not covered by the special tax break for principal residences described above, there are two very important exceptions to the “cancelled debt = taxable income” rule.
The cancelled debt is not income, even if you receive a Form 1099-C, if
- You received the cancelled debt due to bankruptcy filing, or
- To the extent you are insolvent immediately before the cancellation of the debt.
Insolvency means your debts exceed the value of all your assets. You can exclude cancelled debt from income up to the amount that you are insolvent. For example, if you had assets of $80,000 and debt of $100,000, you are considered to insolvent by $20,000. If you had $30,000 in debt cancelled at this time of insolvency, you would have to include only $10,000 ($30,000 minus $20,000) in your income.
Cancelled debt can be a challenging tax situation especially during hard financial times. TurboTax will guide you through the cancelled debt maze, including the new legislation, and help minimize the pain from in these tough situations.