Bankruptcy Can Stop Cancellation of Debt Tax

06 Sep Bankruptcy Can Stop Cancellation of Debt Tax

Bankruptcy can have tax benefits for a homeowner who is facing foreclosure. In fact, bankruptcy can help avoid unexpected taxable income from a home foreclosure. Bankruptcy consultation is important for a homeowner in default who is facing the possibility of foreclosure. Loss of a home is both unfortunate and, in some circumstances, can be a taxable event for the former homeowner.

The IRS considers debt that is cancelled, in full or in part, to be taxable income to the debtor to the extent the financial position of the taxpayer has been improved by the debt cancellation. This means that a credit card company settlement can result in an income tax bill from the Internal Revenue Service. It is even possible for the IRS to charge a tax when your house is foreclosed if the value of the house is less than the amount of the mortgage debt.

Bankruptcy is not the only option to avoid tax from income as a result of foreclosure. There are some other solutions to this problem. First, in the case of a home foreclosure, if all the debt secured against a personal residence was used to buy or substantially improve the house, The Mortgage Forgiveness Debt Relief Act of 2007 offers protection from tax. However, this exclusion from income has a time limit. Second, in all debt cancellation situations, to the extent you owe more debt than the total value of all of your assets, the canceled debt is not considered income for tax purposes.

However, the best alternative to avoid tax on cancelled debt may be bankruptcy. Debt that is canceled in a bankruptcy case is not considered to be income to the bankrupt debtor. The Internal Revenue Code Sec 108(a)(1)(A) excludes debt discharged “in a title 11 case” from the taxpayer’s gross income. Title 11 of the US Code is the federal law on bankruptcy.

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I was admitted to practice in 1978. I am certified as a Consumer Bankruptcy Specialist by the American Board of Certification. I regularly speak on tax and bankruptcy issues at state, regional and national conferences. Years of experience in practice before the Internal Revenue Service and Oregon Department of Revenue have given me the background to resolve a large variety of consumer tax issues.
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