Publication 4687: Canceled Debts, Foreclosures, Repossessions
Understand the tax implications of forgiven debt and property loss. This guide clarifies how to calculate taxable income and report a gain or loss on your return.
IRS Publication 4687, “Canceled Debts, Foreclosures, Repossessions, and Abandonments,” guides individuals through the tax implications when a lender forgives a debt or a taxpayer loses property. It helps taxpayers determine if a canceled debt is taxable income and explains how to report these events on a federal tax return.
Taxable Canceled Debt and Key Exclusions
When a lender forgives or cancels a debt, the Internal Revenue Code generally requires the borrower to include the canceled amount in their gross income. This rule treats the forgiven debt as if the taxpayer received that amount in cash. The lender reports the canceled amount to the taxpayer and the IRS on Form 1099-C, Cancellation of Debt. The amount in Box 2 of this form is the starting point for determining any reportable income.
Several exclusions may allow a taxpayer to avoid including canceled debt in their income. The primary exclusion is for debts discharged in a Title 11 bankruptcy case. If a debt is canceled as part of a bankruptcy proceeding, it is not considered taxable income. This exclusion takes precedence over other exclusions that might apply.
Another exclusion is insolvency. A taxpayer is considered insolvent when their total liabilities are greater than the fair market value (FMV) of their total assets immediately before the debt cancellation. To claim this exclusion, one must complete an insolvency worksheet, as found in Publication 4687, to calculate the extent of insolvency. The amount of canceled debt that can be excluded is limited to the amount by which the taxpayer is insolvent.
An exclusion for Qualified Principal Residence Indebtedness (QPRI) applies to canceled mortgage debt on a taxpayer’s main home. The debt must have been used to buy, build, or substantially improve the home. Refinanced debt also qualifies, but only up to the amount of the old mortgage principal. Through 2025, the maximum excludable amount is $750,000, or $375,000 for a married individual filing separately.
Other specialized exclusions apply to qualified farm and real property business indebtedness, which provide relief in specific business situations.
Foreclosures, Repossessions, and Abandonments
The loss of property through foreclosure, repossession, or abandonment is treated by the IRS as a sale or disposition of the property. This can result in a reportable gain or loss, which is a separate issue from any canceled debt income. The tax treatment of this “sale” depends on whether the debt associated with the property is recourse or nonrecourse.
For recourse debt, where the borrower is personally liable for the full amount of the debt, the transaction is split into two parts for tax purposes. First, a gain or loss is calculated by comparing the property’s fair market value (FMV) at the time of foreclosure to the taxpayer’s adjusted basis. Second, if the loan balance exceeds the FMV, the difference may be canceled by the lender, resulting in cancellation of debt income.
For example, a property with a $200,000 adjusted basis and a $220,000 FMV is foreclosed on to satisfy a $250,000 recourse debt. The taxpayer has a $20,000 gain ($220,000 FMV – $200,000 basis). The remaining $30,000 of forgiven debt ($250,000 loan – $220,000 FMV) is cancellation of debt income, which may be excludable.
With nonrecourse debt, the borrower is not personally liable, and the lender’s only remedy is to seize the property. The amount realized from the sale is the full outstanding debt balance, regardless of the property’s FMV. The gain or loss is the difference between this debt amount and the taxpayer’s adjusted basis.
For instance, if a property with a $200,000 adjusted basis is foreclosed on to satisfy a $250,000 nonrecourse debt, the amount realized is $250,000. This results in a $50,000 gain ($250,000 amount realized – $200,000 basis). There is no separate cancellation of debt income with nonrecourse debt.
How to Report Events on Your Tax Return
After a foreclosure or debt cancellation, taxpayers will likely receive specific information returns from their lenders. Form 1099-A, Acquisition or Abandonment of Secured Property, is sent when a lender acquires an interest in a property that was security for a loan. Form 1099-C, Cancellation of Debt, reports the amount of debt canceled. A lender may combine information from Form 1099-A onto Form 1099-C for a foreclosure.
To claim an exclusion for canceled debt, the taxpayer must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. On this form, the taxpayer will check the box corresponding to the specific exclusion they are claiming, such as for a discharge in a Title 11 case or the QPRI exclusion. The amount of the excluded debt is then entered on line 2.
The gain or loss from the “sale” of the property is reported on Form 8949, Sales and Other Dispositions of Capital Assets. The details from Form 8949 are then summarized on Schedule D (Capital Gains and Losses) of the tax return. This is where the final gain or loss from the foreclosure is calculated.
This information flows to the taxpayer’s Form 1040. Any taxable canceled debt that is not excludable is reported on the “Other Income” line of Schedule 1 (Form 1040). The net capital gain or loss from Schedule D is reported directly on Form 1040.