Generally speaking, the IRS doesn’t count loans or mortgages as income as long as they are still in repayment or have been paid off in full. This status can change if they are forgiven by the lender before you’ve fully paid them off, however. The IRS refers to this as “cancellation of debt income,” or COD for short.
In most cases, regardless of the reason for the loan forgiveness, the IRS will treat the balance amount that you didn’t end up paying off as if it was a direct payment to you. This includes situations such as negotiating down your credit card debt, forgiveness of part of your mortgage and forgiveness of debt on an auto loan due to repossession and sale of your vehicle.
There are very few exceptions to cancellation of debt income. If you took out a mortgage on your primary residence or took out a loan to make improvements to it between 2007 and 2012, there was a temporary measure during that time (due to the subprime lending crisis) that exempted that particular debt forgiveness from being considered income.
The one big, blanket exception to having COD income exempted is demonstrating insolvency in the period just before the debt was canceled. To meet the IRS standard for being considered insolvent, you basically need to owe more than the fair market value of what you own. If the total amount of your insolvency is greater than the canceled debt, you won’t have to pay taxes on it. If you end up partially insolvent as it relates to your canceled debt, then you’ll only pay tax on part of the amount.
If you’ve reached the point of insolvency, it’s important to give consideration to bankruptcy. It may be the best option for financial recovery. Contact us for a free consultation.