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Ellen, Attorney
Category: Bankruptcy Law
Satisfied Customers: 36714
Experience:  Bankruptcy Lawyer. Experienced.
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1) I have roughtly $85,000 in credit card debt and Im in

Resolved Question:

1) I have roughtly $85,000 in credit card debt and I'm in a debt reduction program.
2) I had to sell my house via a short sale and have $365,000 in canceled debt. The house
is in California and I now live in Arkansas.

The credit card companies are hounding me, but I can put with that for the time being. My question is about the tax liablity on the canceled debt. Would I fall under the Debt Relief Act? If not, how would I go about getting a settlement with the IRS?
Submitted: 7 years ago.
Category: Bankruptcy Law
Expert:  Ellen replied 7 years ago.

You can be taxed on the relief of indebtedness income. If the lender accepts less than what you owe on the full balance, this difference will become discharge of indebtedness income and it is taxed as “ordinary income” (See 26 U.S.C. § 61 and §§ 1001 through 1016).

Here are the common exceptions to the IRS discharge of indebtedness income rule. There may be other exceptions as well. You can determine if any apply to your situation.

Common Exceptions:

1. Debts discharged through bankruptcy are not considered taxable income.

2. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.

3. Personal residence. The Mortgage Forgiveness Debt Relief Act of 2007 excludes from taxation discharges of up to $2 million of indebtedness that is secured by a principal residence and is incurred in the acquisition, construction or substantial improvement of the principal residence.

4. If you are insolvent when the debt is canceled, some or all of the canceled debt may not be taxable to you.

Therefore, the discharge of indebtedness income may not be considered taxable income under exception #2, #3 or #4.

I hope that this helps.
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