Cancellation of Debt — 2025 Publ 225 (PDF)

This section explains the general rule for including canceled debt in income and the exceptions to the general rule. For more information on canceled debt, see Pub. 4681.

General Rule

Generally, if your debt is canceled or forgiven, other than as a gift or bequest to you, you must include the canceled amount in gross income for tax purposes. Report the canceled amount on Schedule F if you incurred the debt in your farming business. If the debt is a nonbusiness debt, report the canceled amount as “Other income” on Schedule 1 (Form 1040), line 8.

Special rules apply to C and S corporations and partnerships. See section 108(i), Regulations sections 1.108(i)-0 and 1.108(i)-2, and Pub. 4681 for details.

Form 1099-C. If a federal agency, financial institution, credit union, finance company, or credit card company cancels or forgives your debt of $600 or more, you may receive a Form 1099-C, Cancellation of Debt. The amount of debt canceled is shown in box 2.

Exceptions

The following discussion covers some exceptions to the general rule for canceled debt. These exceptions apply before the exclusions discussed below.

Price reduced after purchase. If your purchase of property was financed by the seller and the seller reduces the amount of the debt at a time when you aren’t insolvent and the reduction doesn’t occur in a chapter 11 bankruptcy case, the amount of the debt reduction will be

treated as a reduction in the purchase price of the property. Reduce your basis in the property by the amount of the reduction in the debt. The rules that apply to bankruptcy and insolvency are explained below under Exclusions .

Deductible debt. You don’t realize income from a canceled debt to the extent the payment of the debt would have been a deductible expense. This exception applies before the price reduction exception discussed above and the bankruptcy and insolvency exclusions discussed next.

Example. You get accounting services for your farm on credit. Later, you have trouble paying your farm debts, but you aren’t bankrupt or insolvent. Your accountant forgives part of the amount you owe for the accounting services. How you treat the canceled debt depends on your method of accounting.

Cash method—You don’t include the canceled debt in income because payment of the debt would have been deductible as a business expense.
Accrual method—You include the canceled debt in income because the expense was deductible when you incurred the debt.

Exclusions

Don’t include canceled debt in income in the following situations.

The cancellation takes place in a bankruptcy case under title 11 of the U.S. Code.
The cancellation takes place when you‘re insolvent.
The canceled debt is a qualified farm debt.
The canceled debt is a qualified real property business debt (in the case of a taxpayer other than a C corporation). See chapter 5 of Pub. 334.
The canceled debt is qualified principal residence indebtedness which is:

a. Discharged before 2025, or

b. Subject to an arrangement that is en tered into and evidenced in writing before January 1, 2026.

The exclusions don’t apply in the following situations.

If a canceled debt is excluded from income because it takes place in a bankruptcy case, the exclusions in situations (2), (3), (4), and (5) don’t apply.
If a canceled debt is excluded from income because it takes place when you’re insolvent, the exclusions in situations (3) and (4) don’t apply to the extent you’re insolvent.
If a canceled debt is excluded from income because it’s qualified principal residence indebtedness, the exclusion in situation (2) doesn’t apply unless you elect to apply situation (2) instead of the exclusion for qualified principal residence indebtedness.

See Form 982, later, for information on how to claim an exclusion for a canceled debt.

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Debt. For this discussion, debt includes any debt for which you’re liable or that attaches to property you hold.

Bankruptcy and Insolvency

You can exclude a canceled debt from income if you’re bankrupt or to the extent you’re insolvent.

Bankruptcy. A bankruptcy case is a case under title 11 of the U.S. Code if you’re under the jurisdiction of the court and the cancellation of the debt is granted by the court or is the result of a plan approved by the court.

Don’t include debt canceled in a bankruptcy case in your income in the year it’s canceled. Instead, you must use the amount canceled to reduce your tax attributes, explained below under Reduction of tax attributes .

Insolvency. You’re insolvent to the extent your liabilities are more than the fair market value of your assets immediately before the cancellation of debt.

You can exclude canceled debt from gross income up to the amount by which you’re insolvent. If the canceled debt is more than this amount and the debt qualifies, you can apply the rules for qualified farm debt or qualified real property business debt to the difference. Otherwise, you include the difference in gross income. Use the amount excluded because of insolvency to reduce any tax attributes, as explained below under Reduction of tax attrib- utes . You must reduce the tax attributes under the insolvency rules before applying the rules for qualified farm debt or for qualified real property business debt.

Example. You had a $15,000 debt that wasn’t qualified principal residence debt canceled outside of bankruptcy. Immediately before the cancellation, your liabilities totaled $80,000 and your assets totaled $75,000. Since your liabilities were more than your assets, you were insolvent to the extent of $5,000 ($80,000 − $75,000). You can exclude this amount from income. The remaining canceled debt ($10,000) may be subject to the qualified farm debt or qualified real property business debt rules. If not, you must include it in income.

Reduction of tax attributes. If you exclude canceled debt from income in a bankruptcy case or during insolvency, you must use the excluded debt to reduce certain tax attributes.

Order of reduction. You must use the excluded canceled debt to reduce the following tax attributes in the order listed unless you elect to reduce the basis of depreciable property first, as explained later.

Net operating loss (NOL). Reduce any NOL for the tax year of the debt cancellation, and then any NOL carryover to that year. Reduce the NOL or NOL carryover 1 dollar for each dollar of excluded canceled debt.
General business credit carryover. Reduce the credit carryover to or from the tax year of the debt cancellation. Reduce the carryover 33 ¹ /3 cents for each dollar of excluded canceled debt.
Minimum tax credit. Reduce the minimum tax credit available at the beginning of the tax year following the tax year of the debt cancellation. Reduce the credit 33 ¹ /3 cents for each dollar of excluded canceled debt.
Capital loss. Reduce any net capital loss for the tax year of the debt cancellation, and then any capital loss carryover to that year. Reduce the capital loss or loss carryover 1 dollar for each dollar of excluded canceled debt.
Basis. Reduce the basis of the property you hold at the beginning of the tax year following the tax year of the debt cancellation in the following order.

a. Real property (except inventory) used

in your trade or business or held for investment that secured the canceled debt.

b. Personal property (except inventory

and accounts and notes receivable) used in your trade or business or held for investment that secured the canceled debt.

c. Other property (except inventory and

accounts and notes receivable) used in your trade or business or held for investment.

d. Inventory and accounts and notes re ceivable.

e. Other property.

Reduce the basis 1 dollar for each dollar of excluded canceled debt. However, the reduction can’t be more than the total basis of property and the amount of money you hold immediately after the debt cancellation minus your total liabilities immediately after the cancellation.

For allocation rules that apply to basis reductions for multiple canceled debts, see Regulations section 1.1017-1(b)(2). Also see Electing to reduce the basis of depreciable property first , later.

Passive activity loss and credit carry- overs. Reduce the passive activity loss and credit carryovers from the tax year of the debt cancellation. Reduce the loss carryover 1 dollar for each dollar of excluded canceled debt. Reduce the credit carryover 33 ¹ /3 cents for each dollar of excluded canceled debt.
Foreign tax credit. Reduce the credit carryover to or from the tax year of the debt cancellation. Reduce the carryover 33 ¹ /3 cents for each dollar of excluded canceled debt.

How to make tax attribute reductions. Always make the required reductions in tax attributes after figuring your tax for the year of the debt cancellation. In making the reductions in (1) and (4) earlier, first reduce the loss for the tax year of the debt cancellation. Then reduce any loss carryovers to that year in the order of the tax years from which the carryovers arose, starting with the earliest year. In making the reductions in (2) and (7) earlier, reduce the credit

carryovers to the tax year of the debt cancellation in the order in which they are taken into account for that year.

Electing to reduce the basis of depreciable property first. You can elect to apply any portion of the excluded canceled debt first to reduce the basis of depreciable property you hold at the beginning of the tax year following the tax year of the debt cancellation in the following order.

Depreciable real property used in your trade or business or held for investment that secured the canceled debt.
Depreciable personal property used in your trade or business or held for investment that secured the canceled debt.
Other depreciable property used in your trade or business or held for investment.
Real property held as inventory if you elect to treat it as depreciable property on Form

The amount you apply can’t be more than the total adjusted basis of all the depreciable properties. Depreciable property for this purpose means any property subject to depreciation, but only if a reduction of basis will reduce the depreciation or amortization otherwise allowable for the period immediately following the basis reduction.

You make this reduction before reducing the other tax attributes listed earlier. If the excluded canceled debt is more than the depreciable basis you elect to reduce first, use the difference to reduce the other tax attributes. In figuring the limit on the basis reduction in (5) under Order of reduction, earlier, use the remaining adjusted basis of your properties after making this elec- tion.

See Form 982, later, for information on how to make this election. If you make this election, you can revoke it only with the consent of the IRS.

Recapture of basis reductions. If you reduce the basis of property under these provisions (either the election to reduce basis first or the basis reduction without that election) and later sell or otherwise dispose of the property at a gain, the part of the gain due to this basis reduction is taxable as ordinary income under the depreciation recapture provisions. Treat any property that isn’t section 1245 or section 1250 property as section 1245 property. For section 1250 property, determine the straight-line depreciation adjustments as though there were no basis reduction for debt cancellation. Sections 1245 and 1250 property and the recapture of gain as ordinary income are explained in chapter 9.

More information. For more information on debt cancellation in bankruptcy proceedings or during insolvency, see Pub. 908.

Qualified Farm Debt

You can exclude from income a canceled debt that’s qualified farm debt owed to a qualified person. This exclusion applies only if you were solvent when the debt was canceled or, if you were insolvent, only to the extent the canceled

Publication 225 (2025) Chapter 3 Farm Income 17

debt is more than the amount by which you were insolvent. This exclusion doesn’t apply to a canceled debt excluded from income because it relates to your principal residence or it takes place in a bankruptcy case.

Your debt is qualified farm debt if both the following requirements are met.

You incurred it directly in operating a farming business.
At least 50% of your total gross receipts for the 3 tax years preceding the year of debt cancellation were from your farming business.

For more information, see Pub. 4681.

Qualified person. This is a person who is actively and regularly engaged in the business of lending money. A qualified person includes any federal, state, or local government, or any of their agencies or subdivisions. The USDA is a qualified person. A qualified person doesn’t include any of the following.

A person related to you.
A person from whom you acquired the property (or a person related to this person).
A person who receives a fee from your investment in the property (or a person related to this person).

For the definition of a related person, see Related persons under At-Risk Amounts in Pub. 925.

Exclusion limit. The amount of canceled qualified farm debt you can exclude from income is limited. It can’t be more than the sum of your adjusted tax attributes and the total adjusted basis of the qualified property you hold at the beginning of the tax year following the tax year of the debt cancellation. Figure this limit after taking into account any reduction of tax attributes because of the exclusion of canceled debt from gross income during insolvency.

If the canceled debt is more than this limit, you must include the difference in gross income.

Adjusted tax attributes. Adjusted tax attributes means the sum of the following items.

Any NOL for the tax year of the debt cancellation and any NOL carryover to that year.
Any general business credit carryover to or from the year of the debt cancellation, multiplied by 3.
Any minimum tax credit available at the beginning of the tax year following the tax year of the debt cancellation, multiplied by
Any net capital loss for the tax year of the debt cancellation and any capital loss carryover to that year.
Any passive activity loss and credit carryovers from the tax year of the debt cancellation. Any credit carryover is multiplied by
Any foreign tax credit carryovers to or from the tax year of the debt cancellation, multiplied by 3.

Qualified property. This is any property you use or hold for use in your trade or business or for the production of income.

Reduction of tax attributes. If you exclude canceled debt from income under the qualified farm debt rules, you must use the excluded debt to reduce tax attributes. (If you also excluded canceled debt under the insolvency rules, you reduce the amount of the tax attributes remaining after reduction for the exclusion allowed under the insolvency rules.) You must generally follow the reduction rules previously explained under Bankruptcy and Insolvency . However, don’t follow the rules in (5) under Order of re- duction, earlier. Instead, follow the special rules explained next.

Special rules for reducing the basis of property. You must use special rules to reduce the basis of property for excluded canceled qualified farm debt. Under these special rules, you only reduce the basis of qualified property (defined earlier). Reduce it in the following order.

Depreciable qualified property. You may elect on Form 982 to treat real property held as inventory as depreciable property.
Land that’s qualified property and is used or held for use in your farming business.
Other qualified property.

Form 982

Use Form 982 to show the amounts of canceled debt excluded from income and the reduction of tax attributes in the order listed on the form. Also use it if you’re electing to apply the excluded canceled debt to reduce the basis of depreciable property before reducing tax attributes. You make this election by showing the amount you elect to apply on line 5 of the form.

When to file. You must file Form 982 with your timely filed income tax return (including extensions) for the tax year in which the cancellation of debt occurred. If you timely filed your return for the year without electing to apply the excluded canceled debt to reduce the basis of depreciable property first, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). For more information, see When To File in the Form 982 instructions.