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What to Do in Case of an Economic Downturn #2: Debt

August 24th

In this complex economic period, many Americans fear the affects that debt might have on their tax bills. Even further, personal debt can greatly increase the difficulty in paying taxes and lead to tax debt.  Here are a number of potential scenarios related to debt issues you may face during an economic downturn, and some helpful tips for reconciling these problems with your taxes.

 Tax Issues

1. Losing a Home Through Foreclosure. Unfortunately, these days many people are losing their homes. The good news is that, under the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers can generally exclude income from the discharge of debt on their principal residence or mortgage restructuring. This exception does not, however, apply to second homes or vacation properties. In some cases, it may be possible to file an amended tax return for previous tax years.

2. Debt Forgiveness. The impact of debt forgiveness or cancellation on your taxes depends on your individual facts and circumstances. Generally, if you borrow money from a commercial lender, and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes. The lender is usually required to report the amount to the IRS and to you on a Form 1099-C, Cancellation of Debt. However, there are several exceptions in which cancelled debt may not be taxable, such as insolvency or bankruptcy.

3. Primary Residence is Sold at a Loss. Given the crash in the property market, it is quite common at present for properties to be sold at a loss. Unfortunately, any losses from the sale of personal-use property, including primary residences or items such as a car, are not tax deductible. Such losses are also not eligible for the capital gains loss deduction of up to $3,000 annually.

 
 
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