Forgiveness of Debt Income in Loan Modifications

David A. Holmes, Attorney
David’s practice focuses on asset protection, corporate and business law, civil litigation with an emphasis in contract, commercial and construction disputes, and real estate.

Many clients are pursuing loan modifications, including short sales, that involve the lender writing off a portion of the loan balance.  While obtaining this form of relief can be very beneficial, it is important to recognize that so called “forgiveness of debt” generally constitutes income under the tax code.

In almost every situation, the lender will report the amount written off to the IRS on form 1099-C.  From there it is the borrower’s responsibility to reflect the income on the borrower’s tax return and either pay the applicable tax or properly claim an exemption.

A number of exemptions are available, including exemptions where the debt forgiven relates to the taxpayer’s primary residence, and where the taxpayer is insolvent.

Here are links to IRS publications that cover the available exemptions:

Canceled Debts, Foreclosures, Repossessions, and Abandonments

Tax Relief for Struggling Homeowners

As always, consultation with an attorney and accountant is advised.