Where Does Cancellation of Debt Go on Form 1040?

When a debt you owe is forgiven or discharged for less than the full amount, this event is known as cancellation of debt (COD). This can occur in various situations, such as a lender agreeing to a reduced payment or a debt being discharged in bankruptcy. For tax purposes, the amount of debt that is canceled is generally considered income to the taxpayer, as it represents a financial benefit received without an obligation to repay.

Taxability of Cancellation of Debt

The Internal Revenue Service (IRS) views canceled debt as taxable income because the taxpayer receives an economic gain by no longer being required to repay a financial obligation. Common scenarios include mortgage debt forgiveness, settlements with credit card companies, or repossessions where the outstanding loan balance is forgiven. Lenders are required to issue Form 1099-C, “Cancellation of Debt,” to both the taxpayer and the IRS if they cancel $600 or more of debt.

Form 1099-C indicates the amount of debt canceled in Box 2. This document serves as notification of the debt cancellation and the amount the IRS considers as income. Understanding the information on Form 1099-C is the initial step in determining the tax implications of canceled debt.

Reporting Taxable Cancellation of Debt

If the canceled debt is taxable, you must report this income on your federal income tax return. The taxable portion of canceled debt, as shown in Box 2 of Form 1099-C, is reported on Schedule 1 (Form 1040), Additional Income and Adjustments to Income. Enter this amount on Line 8z, labeled “Other income,” of Schedule 1.

This amount is incorporated into your total income calculation on your main Form 1040. Only the taxable amount, after considering any applicable exclusions, should be reported.

Exclusions from Cancellation of Debt Income

While canceled debt is taxable, there are specific circumstances where it can be excluded from your gross income. One common exclusion applies if you are insolvent, meaning your total liabilities exceed the fair market value of your assets immediately before the debt cancellation. In this situation, the canceled debt can be excluded up to the extent of your insolvency.

Another exclusion applies to debt discharged in a Title 11 bankruptcy case, which means the debt was discharged by a U.S. bankruptcy court. Qualified Principal Residence Indebtedness (QPRI) can also be excluded if it was debt incurred to acquire, construct, or substantially improve your main home and was secured by that home. This exclusion applies to discharges before January 1, 2026, and is limited to $750,000 ($375,000 for married individuals filing separately) for discharges after December 31, 2020.

Other exclusions exist for Qualified Farm Indebtedness, which applies to certain debt incurred by a qualified farmer, and Qualified Real Property Business Indebtedness, which pertains to debt related to real property used in a trade or business. Taxpayers should consult IRS Publication 4681 for detailed guidance on each exclusion.

Reporting Excluded Cancellation of Debt

When you qualify for an exclusion from cancellation of debt income, you must report this exclusion to the IRS. This is done by filing Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness,” with your federal income tax return. Form 982 informs the IRS that you are excluding the canceled debt from your income and provides the reason.

Beyond reporting the exclusion, Form 982 also requires you to reduce certain tax attributes by the amount of the excluded canceled debt. Tax attributes, such as the basis of property, net operating losses, or other tax credits, are reduced to offset the tax benefit of the excluded income. This reduction ensures that while the canceled debt is not taxed immediately, its tax benefit is accounted for over time.