Forgiven debt is taxable income
Getting your credit card bill cut from $8,000 to $4,000 certainly helped your personal bottom line. It also could be a boon to the U.S. Treasury.
Why? Whenever you get a creditor to write off debt, the tax law generally considers the amount earned income. That means it's taxable to you. Expect the accommodating debtholder to send you (and the IRS) a Form 1099-C or similar statement detailing your discharge of indebtedness as miscellaneous income.
Not every debt settlement, however, has to pad Uncle Sam's pocket. Under the Mortgage Debt Relief Act that became law in 2007, some homeowners who were granted forgiveness of mortgage debt in 2016 won't have to pay taxes on that amount.
There are some restrictions:
- The forgiven debt amount is limited to up to $2 million, or
- $1 million for a married person filing a separate tax return.
- The forgiven loan must have been taken out to buy or build a primary residence, not a second home or vacation home.
This tax break is temporary and will end if Congress doesn't retroactively extend mortgage debt relief beyond 2016.