If you had debt cancelled and are no longer obligated to repay the debt, you generally must include the amount of cancelled debt in your income. However, if it was a discharge of qualified farm indebtedness, the debt generally does not have to be added to your return as income. The exculsion relating to qualified farm indebtedness does not apply to a discharge that occurs in a title 11 case or to the extent you were insolvent.
What is qualified farm indebtedness?
Qualified farm indebtedness is the amount of indebtedness incurred directly in connection with the trade or business of farming. In addition, 50% or more of your aggregate gross receipts must be from the trade or business of farming for the 3 tax years immediately preceding the tax year that the indebtedness was discharged.
Secondly, the discharge must have been made by a qualified person. Generally, a qualified person is an individual, organization, etc. who is actively and regularly engaged in the business of lending money. This person cannot be:
- related to you; or
- the person from whom you acquired the property; or
- a person who receives a fee with respect to your investment in the property.
If the person who released your from the debt was any of those, you do not qualify to exclude that debt. It must be included in your income.
Also, a qualified person includes any federal, state, or local government or agency or instrumentality thereof.
What amount of cancelled debt can be excluded from income?
You cannot exclude more than the totoal of your:
- tax attributes (determined under section 108(g)(3)(B)); AND
- basis of property used or held for use in a trade or business or for the production of income.
Any amount in excess of the total of 1 and 2 must be included in your income.
How to Report
When reporting the exclusion of debt, the debt discharge amount will be applied to reduce the tax attributes in the following order:
- Any net operating loss (NOL) for the tax year of the discharge (and any NOL carryover to that year) (dollar for dollar);
- Any general business credit carryover to or from the tax year of the discharge (33 cents per dollar);
- Any minimum tax credit as of the beginning of the tax year immediately after the tax year of the discharge (33 1⁄3 cents per dollar);
- Any net capital loss for the tax year of the discharge (and any capital loss carryover to that tax year) (dollar for dollar);
- The basis of property (dollar for dollar);
- Any passive activity loss (dollar for dollar) and credit (33 1⁄3 cents per dollar) carryovers from the tax year of the discharge; and
- Any foreign tax credit carryover to or from the tax year of the discharge (33 1/3 cents per dollar).