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Running a successful business means having accurate financial information. We offer our services as temporary or on-going and no matter what you need, you will receive the best in personalized, quality service that only DD&A can offer.

Trusted Partner

With over 20 years of management experience, David Defrance & Associates located in Midland, TX offers that experience for individual and business services as well as being a leading consulting firm in West Texas.

Debt Forgiveness

Debt forgiveness income: The big three - credit cards, car loans and mortgages

Generally, debt that is forgiven or cancelled by a lender must be included in your taxable income. Debt that a lender discharges or cancels is referred to as debt forgiveness income or cancellation of debt income ("COD" income). A lender's cancellation of debt will typically result in income to the borrower unless a specific exception under Internal Revenue Code Sec. 108 applies.

The IRS generally recognizes four situations where cancelled debt does not result in taxable income and therefore does not have to be reported as income:

  1. The debt has already been discharged through a bankruptcy proceeding under title 11 of the Bankruptcy Code;
  2. You are insolvent, meaning that your total debts exceed your total assets, when the cancellation of debt occurs;
  3. The indebtedness is due to a qualified farm expense ("qualified farm indebtedness");
  4. The indebtedness is due to certain real property business losses ("qualified real property business indebtedness").

However, certain mortgage debt that is forgiven by a lender, regarded as "qualified principal residence indebtedness," is currently (for the next two years) excluded from cancellation of debt income and, therefore, does not result in taxable income to certain homeowners.

Credits cards and car loans

Code Sec. 108 does not exclude from an individual's gross income credit card debt that is forgiven by a lender, or any outstanding and unpaid debt on a car loan forgiven by a lender. The amount of forgiven debt is reported by the lender on Form 1099-C, Cancellation of Debt, which is sent to the individual. The amount of forgiven debt from Form 1099-C must be reported as income.

Example. You have an outstanding credit card bill of $8,000. You are unable to pay the total amount but reach a compromise with your credit card company in which you settle the debt for $3,500. The Tax Code treats you as having realized a personal net gain of $4,500, even though you have not actually received any money. You will have to report this amount as income.

Example. You purchase a $32,000 SUV in January of last year and took out a $30,000 loan with $700 monthly payments. Each monthly payment is $500 principal and $200 interest. In September 2008, when the vehicle is worth $19,000, you stop making monthly payments, the vehicle is repossessed, and the car loan company forgives $1,000. In September 2008, your car loan was paid down by $10,000 to $20,000. The repossession is considered a sale in which you incur a $1,000 non-deductible personal loss and forgiveness of the $1,000 loan would be income for tax year 2008.

Mortgage Debt Relief

The Mortgage Forgiveness Debt Relief Act of 2007 amended Code Sec. 108 to provide mortgage debt forgiveness relief for certain property. This new law excludes from tax discharges of up to $2 million of indebtedness that is secured by a principal residence (i.e. no vacation homes or second homes), and was incurred in order to acquire or construct the principal residence, or make a substantial improvement to it (sometimes referred to as "acquisition indebtedness"). This special relief is only temporary though. It is available for income from the discharge of qualified principal residence indebtedness that was incurred in 2007 or 2008, and through 2009.

Example. Tom's principal residence is subject to a $250,000 mortgage debt. Tom's creditor forecloses on the property in 2008. Due to declining real estate values, the residence is sold for $175,000 later that year. Tom has discharge of indebtedness income totaling $75,000 ($250,000 - $175,000).

Additionally, this relief from COD income also includes refinancing of such debt to the extent that the refinancing does not exceed the amount of the original indebtedness.

Caution. Homeowners who took advantage of the run up in real estate prices and engaged in "cash-out" refinancing, in which the funds were not put back into the home but instead were used to pay off credit card debt, tuition, medical expenses, or other expenses, are not covered under this relief. This type of indebtedness is fully taxable COD income, unless one of the Code Sec. 108 exceptions applies.


If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.