When you borrow money from a creditor who later cancels the debt for any reason, then the cancelled amount will have to be included when you file your income tax papers.
Initially when you borrowed a sum of money from a lender, then the loan proceeds need not be included in your income as you anyway have to repay the lender back.
But, when a debt cancellation takes place, then you become obliged to report this amount in your income as you no longer need to pay your creditor.
In usual circumstances, the lender informs the debtor of this amount using the IRS Form 1099-C, cancellation of debt.
As per IRC section 6050P, a lender has to file Form 1099-C if the amount cancelled equals or is more than $600 with the IRS and a copy has to be sent to the borrower.
Cancellation of debt is a real good advice in many situations but you are taxable most of the time.
But there are some situations and circumstances under which you are not taxable for debt cancellation.
One of most common situations is bankruptcy; this is why most often debt cancellation is suggested as bankruptcy advice.
The second circumstance is insolvency where once again the cancelled debts are not taxable to you.
Another scenario is when the debt cancelled is from a mortgage on a property or home lost in foreclosure, sold through a short sale or comes from a restructured mortgage.
The forgiven amount will still need to be filed in your tax returns but must be done on Form 982 and not on Form 1099-C for which you will be tax exempted.
Another bankruptcy advice is to use a Form 1099-A, Acquisition or Abandonment of Secured Property which has to be filed if an individual fails to make loan payments that has been secured using a property.
In such situations, the lender can grant a debt cancellation and foreclose on the property thereby repossessing it.
A Form 1099-A is sent by the lender to the borrower in this scenario which he will have to file.
This form is only used for homes and properties and not for belongings like car etc.
When a foreclosure takes place, it is usually regarded as sale of the property but unlike in usual sales, there is no selling price quoted and this is why 1099 Form-A becomes relevant.
This Form will contain the sale date and also the amount sold for.
Multiple Forms of 1099-A can be sent by the lender to the borrower for a single property.
Sometimes a Form 1099-A is sent especially if the property has been foreclosed and any debt borrowed is cancelled by the lender.
If the foreclosed property was your home, then it will have to be reported on Schedule D where both the selling date and price will have to be entered.
If the property foreclosed is a rental, then the information to be reported is the same but you will need to use Form 4797 instead of 1099-A or C.