Debt Forgiveness Can Bite Come Tax Time

Debt forgiveness is a great thing. A lender that decides to forgive some part of one’s loans is great, but it includes a caveat. The hitch is that the pardoned debt is treated and taxed as income by the Internal Revenue Service, which will hurt come tax time.

Not so great news from the government

When a borrower talks to a loans lender and promises to pay part of the debt, the debt will sometimes do some debt cancellation. This is only applicable to people who cannot afford their payments but still promise to pay some of the loan back. People love that this safety net is around when they need help.

On the subject of debt forgiveness, the Wall Street Journal reports that many people will be annoyed to hear the government considers that income. It is technically a bonus towards petty cash and income, which means it is taxable.

Borrowers have to report the cash on their tax forms with the form 1099 C, which forgiving lenders must give out.

Involves large mortgages

Occasionally, a home loan that is pardoned is exempt from taxes, but much of the time, it is not. In fact, debt forgiveness could be really annoying when it comes to forgiveness of a home loan. A 1099 C has to be used any time the lender agrees to cut back principle or agrees to a short sale.

The Home loan Forgiveness Debt Relief Act is a law that the government passed in 2007 that allows certain homeowners who get foreclosed on to stay away from the taxes on the debt. CBS explained that people who were in the Home Affordable Refinancing Program, or HAMP, were able to keep away from the tax.

It does not contain any second-home mortgages, though it does consist of all primary residences, according to the Wall Street Journal.

Negotiations saved it

That law was set to expire last year, but was saved in the “fiscal cliff” negotiations. However, it will lapse before 2014, unless extended. That said, as CBS points out, debt forgiveness for home loans could be claimed over a period of three years or all it once – forgiven homeowners who have not claimed it yet should claim it all this year and reap the benefit of the exemption, if applicable.

Over 1 million 1099 C forms were filed in 2003 with the Internal Revenue Service. In 2013, that is anticipated to be 6.5 million. There is more debt cancelation occurring now more than ever, according to Creditcards.com.

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