Don Priebe -January 2011Cancellation of Debt1 Other Income Awards, Prizes Gambling Income Election,...

Don Priebe -January 2011 Cancellation of Debt 1

Other Income Awards, Prizes Gambling Income Election, Jury Duty Non-employee Compensation Cancellation of Debt


Cancellation of Debt

Not covered in Pub 4491 (text book) Pub 4681 (rev April 2010) Mandatory training and certification

module available on Link and Learn website (http://www.irs.gov/app/vita/)


Basic Concept

Cancellation of a legal debt is taxable income to the debtor in the amount of the debt cancelled.

COD is reported on a 1099-C There are a myriad of exceptions

to the basic concept.


What is in-scope

Only two specific cases of cancellation of debt are in scope for AARP/TCE Cancellation of consumer debt with full

inclusion of income (new this year) Cancellation of mortgage debt on principle

residence with full exclusion from income Pub 4731 is a two page worksheet to

determine if COD is in-scope. (in the Pub 4012 resource book)


Example – credit card

Sam and Jan were doing fine until Jan lost her job. They maxed out their credit cards and stopped making payments.

The credit card banks started collection proceedings, but when they saw that Sam and Jan had no real assets to attach, they settled for 50 cents on the dollar and canceled the rest.

Their KIA was repossessed


Form 1099-C

12,200

Bank of America

111-11-1111


Scope worksheet – credit card


Reporting credit card 1099-C These are reported as Other

Income on form 1040 line 21 There is no 1099-C input form on

TaxWise Go to 1040 line 21 ‘Type’ and link

to ‘Form 1040 Line 21 Other Income’


What happens if there is interest in box 3

If the interest would have been deductible (e.g. mortgage interest) subtract it from box 2

If the interest would not have been deductible (e.g. credit card interest) do not subtract from box 2

It is out of scope


What if the client was insolvent just before the debt

was forgiven You would fill out the insolvency

worksheet in Pub 4681 The forgiven debt would not be

included in income It is out of scope


What happens to debt forgiven in bankruptcy

The forgiven debt is not included in income

It is out of scope


Cancellation of debt - mortgage

Since the cancellation of mortgage debt and/or foreclosure is relatively rare, and involves a large amount of money, make use of the IRS pubs and worksheets

Remember – You must be specifically trained and certified in Cancellation of Debt to do these returns.


Mortgage Debt Special regulations apply to

forgiveness of mortgage debt on your principle residence

Up to One Million dollars of qualified debt can be forgiven without inclusion in taxable income ($2.0M MFJ)

Only the simplest scenarios are in-scope


Example - mortgage

Sam and Jan had bought a house at the top of the real estate boom. They paid $600K for the house - $60K down and a mortgage for $540K.

After living in the house for three years, not only did Jan lose her job, but the real estate market tanked. They still owe $530K on the house but now it’s only worth $480K. They stop making their mortgage payments.

The bank forecloses on the mortgage, and Sam and Jan are evicted. The bank sells the house for $480K, but they are still on the hook for the remaining $50K. (Recourse loan.)

Rather than sue Sam and Jan for the $50K that they don’t have, the bank decides to write it off as a bad debt and sends Sam and Jan a 1099-C for $50K.


Form 1099-C for mortgage


Scope worksheet - mortgage


Form 982 Cancellation of qualified mortgage debt

is reported on form 982, not on form 1040 line 21

On form 982 check box 1e and enter the amount on line 2

Leave line 10b blank unless taxpayer still owns the house after the debt forgiveness (Per IRS instructions; TaxWise disagrees)


TaxWise form 982


Form 1099-A

If the residence is taken by the bank, they may issue a 1099-A giving the details.

Alternately they may include the information on a 1099-C

Refer to Pub 4681 for processing the 1099-A with or without a 1099-C


Form 1099-A for mortgage


Example - foreclosure This is treated as the sale of a

principle residence Use Sale of Home worksheet 2 on

Schedule D with special attention to the selling price


Foreclosure – Selling Price If borrower is responsible for balance of

debt (box 5 checked yes; recourse loan), sales price is lesser of outstanding debt or FMV

If borrower is not responsible for balance of loan (box 5 checked no; non-recourse loan) sales price is outstanding debt

Pub 4681 has worksheet Example sales price - $480,000


Pub 4681 Worksheet


Foreclosure – Basis Basis is calculated as usual

Purchase price Plus purchase closing costs Plus improvements Plus selling closing costs Less deductible disaster losses

Example basis - $600,000


Reporting the Sale Link and Learn recommends

reporting any sale documented on a 1099-A

The Sch D worksheet does not carry to Sch D for residence sales at a loss

Manually enter


Cancellation of debt without repossession If the bank simply cancels (part of)

the mortgage debt without repossessing the house … Line 10b of the 982 has an entry The basis of the house is reduced by

the amount on 10b No 1099-A is issued No Schedule D is prepared

Don Priebe -January 2011Cancellation of Debt1 Other Income Awards, Prizes Gambling Income Election,...

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