Debt and Taxes: What You Need to Know

If you filed for personal bankruptcy and/or had your house foreclosed on in 2010, you may be wondering how those actions will affect your taxes (due April 18th). Here’s an overview of what you might be able to expect, depending on what specifically happened in your finances during the last 12 months.

Surrendered Property & Canceled Debts in Bankruptcy

As you likely already know, one of the powers of the bankruptcy court is to allow filers to surrender their property (including a home or a car) to their lenders if they are unable to continue making payments on their loans. Specifically:

Surrendering a car: In both Chapter 13 and Chapter 7, filers have the option of surrendering their car to their lenders (that is, giving up their car) in exchange for having their debt on that car canceled. For filers who do not need their vehicle for work and/or who cannot afford to continue making payments on it, this can work well.
Surrendering a house: If a filer’s bank plans to foreclose on her home, filing for bankruptcy may allow her to cancel the remaining debt associated with the mortgage.

It’s important to note that debts canceled in bankruptcy court are not considered taxable income. But what happens when you face a foreclosure or repossession outside of a bankruptcy case? A recent post from Credit.com outlines the basics.

Tax, Canceled Debts & Surrendered Property without Bankruptcy

The tax forms associated with these two financial concerns are the 1099-A (“Acquisition or Abandonment of Secured Property”) and the 1099-C (“Cancelation of Indebtedness Income”). Here’s when they matter.

Discharged debts as income: In some states, property you lose (through repossession or foreclosure) could affect your income. For example, if you began the year owing $100,000 on a mortgage, had your home foreclosed on during the year and so ended the year without an active mortgage, some of that loan amount might be taxable.
Fair market value vs. loan principal: One important factor that determines whether you’ll have to pay taxes and how much you’ll have to pay is the difference between the fair market value of an asset and the amount your loan covered. In other words, if your asset was worth less than your loan amount at the time of repossession, you may have to pay taxes on the difference.

A more complete explanation of these tax forms is available from the Credit.com post.

As with all legal codes, the rules that govern debt forgiveness, surrendered property and taxes are complex and highly nuanced. If you’d like an idea about what tax forms you’re required to fill out, you may benefit from speaking with a lawyer or tax specialist in your state.

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