If you borrowed money from an organization or an individual, perhaps to buy a home, and they cancel your debt, then the money they gave you will be considered taxable income. You must pay taxes on this amount by reporting it to the IRS when you file your tax returns at the end of the fiscal year. Canceled debt is treated the same as income.
It can be relieving when someone forgives your debt, but remember that you still need to pay taxes on that. Many people are unaware of this law and end up not reporting their income, thus leading to an IRS audit. If you do not want to receive an audit letter from the IRS, hire professional tax planning services in Troy, MI, to pay the right taxes.
Top tax tips about debt collection
- Canceled loan on your main home.
If you had taken a loan for the construction, modification, or improvement of your main home, and the creditor cancels or forgives your loan due to foreclosure or loan modification, it may be counted as your taxable income. However, you can obtain an exclusion from paying taxes on your forgiven or canceled loan by ensuring that your main home is collateral to your mortgage.
- Modified loan agreement.
If your creditor has allowed for a modification of your current loan agreement to make it easier for you to repay, the excluded loan amount may be excluded from your taxable income. The modification could be lowering the interest rates, forgiving some of the debt, or extending the loan repayment period.
You can also enjoy an exclusion of taxes if you get your home loan forgiven through the government program Home Affordable Modification Program (HAMP).
- Refinanced mortgage.
If your creditor has agreed to refinance the mortgage terms to make them more favorable for you, you may be able to exclude the canceled loan depending on certain conditions. However, you must use the funds you receive from the mortgage refinancing to buy, build or make improvements to your home. The refinancing should be directly connected with your property’s acquisition or improvement.
- Other homes and properties.
It is worth noting that the tax exclusions listed above are only available for your main home, typically your first residential purchase. Canceled loan amounts for second homes, rental property, or others may still be taxable. You must report the canceled amount on your tax return as your income and pay the taxes. However, there may still be tax laws that allow you certain deductions. Hire a professional tax preparer to understand taxing better.
