When you have debt that is cancelled or forgiven, that must be included in your taxable income. However, you can use Form 982 to claim an exclusion from paying tax on that forgiven debt if you either filed bankruptcy on the debts or if you can show that you were insolvent at the time this occurred.
Being insolvent means that your liabilities are more than your assets. You would attach a statement to Form 982 which would be a listing of all the assets and liabilities that you had at the time this happened. Here is a simplified example of such a statement:
Home: $100,000 (current market value)
Car: $5,000 (current market value)
Cash in Bank: $1,000
Total Assets: $106,000
Balance owed on home mortgage: $90,000
Balance owed on car loan: $3,000
Balances owed on credit cards: $20,000
Total Liabilities: $113,000
Using the above example, your liabilities exceed your assets by $7,000. So this is how much you could exclude of your forgiven debt from taxable income.
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