Cancellation of debt occurs when the lender from whom you borrowed money later cancels the debt. Depending on the circumstances, you may have to include the cancelled amount as income on your tax returns.

Borrowed money are not taxable income because you are obligated to pay it back. However, when that obligation is later forgiven or cancelled, the amount cancelled becomes a reportable income because you no longer have an obligation to repay the lender.

Lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Depending on the circumstances, cancelled debts are not always taxable. Below are the exceptions:

1. Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.

2. Insolvency: You are insolvent when your total debts are more than the fair market value of your total assets. If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.

3. Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.

4. Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. The lender cannot pursue you personally in case of default.

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