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Form 1099-C: This represents debt owed by the taxpayer that is written off by the lender as noncollectable. Form 982 is used on the tax return to determine any exclusion from income and any non-excluded income is reported on Line 21 of Form 1040 as "Canceled Debt"
The following exceptions MAY apply:
To the extent insolvent (liabilities exceed assets)*
Certain Farm debts
Non-recourse loans (box 5 of 1099C not checked)
Qualified personal residence debt**
Qualified real property business debt
*When you receive a 1099C that is not personal residence debt or from bankruptcy, the most important thing to do is establish the extent of your insolvency. Using the date on the 1099C, determine how much you owe and how much you own. Include the debt amount from the 1099C.
What you own includes the FMV of your home and cars (use kbb.com for cars) as well as all money you have in bank accounts and investments along with the value of anything else you own.
What you owe includes the canceled debt, credit card bills, car loans, home loans, student loans and anything else you owe to anyone.
If what you owe is more than what you own, the difference can be subtracted from the canceled debt before including it as income. If it is larger than the canceled debt, none is included as income. Use Form 982 to record this.
Be careful! If the numbers are close, you need to get accurate information as to the value of your assets. Appraisals are the best, but website and realtor comps may be accepted.
Obviously, if the numbers are dramatic ($100000 upside down on your house with no other significant assets and $5000 canceled debt) you don't need to be quite as psycho in record keeping. Still, take the time to get the best possible numbers NOW, while the records are easy to get, so you don't have to backtrack later.
**It has to be your personal residence at the time of foreclosure. There is some debate on this as to whether you need to be living in the home the day of foreclosure, but most take the reasonable position that if you leave the home due to imminence of foreclosure, you can exclude it as personal residence. The 2 out of 5 year rule for excluding gain does not apply here, though the code can make you think it does. The definition of "personal residence" from that part of the code applies, not the time rules.