This year was the first year I claimed a debt as a source of income on my tax return, a canceled debt that is. For long time readers, you may remember that I was paying down a crummy line of credit – a line of credit that was charging me 29.99% interest! Obviously, I was not happy about this interest rate. I was able to make a deal with the original debtor and reduce my total amount due by $1,561 – a huge savings. The remaining portion I paid off or transferred to a 0% interest rate loan until the end of this year (so I’m still paying off a small portion of this debt using Dave Ramsey’s Debt Snowball method.)

However, I received a 1099 -C for that canceled debt. I ended up having to claim the canceled debt as income. Since the amount wasn’t huge, it didn’t affect my taxes in the long run. However, it got me thinking about how this might affect someone who is in the process of short-selling their home, for instance. Here is a description (line 21 on a 1040 if you’re interested) from the Federal Tax website:

Form 1099-C. If an applicable financial entity cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt.

I researched this information a little more than normal because I personally know someone in the process of a short sale and wondered if they would have to claim a large portion as income once the sale goes through. There were many exclusions to this rule and it is a little bit confusing, if I do say so myself. Had I asked the creditor to grant me the decrease in principal as a gift, I might not have had to include this an income; complicated, but true.  With further research, I found that there is currently a moratorium on canceled debt when it comes to residential real estate:

The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. This provision applies to debt forgiven in calendar years 2007 through 2012.

I guess this will come as a relief to those short-selling their homes, as long as they can close the deals before Dec. 31, 2012.

Have you ever received a 1099-C? Have you had any debts canceled that fell into the exclusion category?