If you had a debt cancelled during the tax year, you generally need to report this as income on your return.
However, if any of the following apply, you may be eligible to exclude the cancellation of debt from your income. You may exclude the cancellation of indebtedness if it was a:
- Discharge of qualified principal residence indebtedness
- Discharge of indebtedness in a title 11 case
- Discharge of indebtedness to the extent insolvent (not in a title 11 case)
- Discharge of qualified farm indebtedness
- Discharge of qualified real property business indebtedness
The majority of taxpayers will only qualify with reasons 1, 2 or 3 to exclude cancelled debt. It is uncommon for individuals to qualify for reasons 4 or 5.
If you meet the requirements for excluding your cancellation of debt, you may exclude the applicable amount from income. However, the cancellation of debt must be reported to you and the IRS on Form 1099-C. You could then exclude the cancellation of debt with Form 982.
Publication 4681 can provide you with more information.