Exceptions and Exclusions

Some canceled or forgiven debts may be eliminated from income by applying exceptions, or reduced by applying exclusions to the general rule. Exceptions are applied before exclusions.

Exceptions

Exceptions may allow the taxpayer to eliminate the following types of canceled debt from income:

• Gifts and bequests
• Certain student loans (e.g., doctors, nurses, and teachers serving in rural or low-income areas)
• Deductible debt (e.g., home mortgage interest that would have been deductible on Schedule A)
• Price reduced after purchase (e.g., debt on solvent taxpayer's property is reduced by the seller; basis of property must be reduced)

For more information on exceptions, refer to Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

Exclusions

There are several exclusions from the general rule for reporting canceled debt as income.

Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, must be filed with the taxpayer's return to show the amount of the canceled debt excluded.

The exclusions are:

• Discharge of debt through bankruptcy
• Discharge of debt of insolvent taxpayer
• Discharge of qualified farm indebtedness
• Discharge of qualified real property business indebtedness
• Discharge of qualified principal residence indebtedness