Internal Revenue Code (IRC) Section 61 “Debt Forgiveness” Explained

When a lender forgives or cancels a debt you owe, the IRS generally treats the canceled amount as taxable income. Internal Revenue Code Section 61(a) lists “income from discharge of indebtedness” as part of gross income. There are important exceptions and exclusions, mainly under IRC Section 108, and many people qualify for one without realizing it.

Form 1099-C

Lenders that cancel $600 or more of debt generally send Form 1099-C, Cancellation of Debt. You must report taxable canceled debt even if you don’t receive the form. A 1099-C doesn’t automatically mean the amount is taxable. It may be excludable.

Exclusions Under Section 108

• Bankruptcy: debt discharged in a Title 11 bankruptcy case is excluded.
• Insolvency: if your total liabilities exceeded your total assets immediately before the cancellation, you can exclude the canceled debt up to the amount you were insolvent. An insolvency worksheet is in IRS Publication 4681.
• Qualified farm indebtedness and qualified real property business indebtedness, subject to specific rules.
• Qualified principal residence indebtedness: mortgage debt on your main home, up to $750,000. This exclusion applies only to discharges before January 1, 2026, or under a written arrangement entered into before that date. Mortgage debt forgiven after 2025 generally needs another exclusion, such as insolvency.
• Student loans: discharges because of the student’s death or total and permanent disability are permanently excluded (an SSN is required on the return). Some programs, such as Public Service Loan Forgiveness, are excluded under separate rules. The broad temporary exclusion for other student loan forgiveness ended after 2025.

Most exclusions are claimed on Form 982, and you may have to reduce tax attributes such as loss carryovers or the basis of your property.

Items That Aren’t Cancellation-of-Debt Income

• Debts canceled as a gift or bequest
• A reduction in purchase price negotiated directly with the seller
• Debts whose payment would have been deductible, for example for a cash-basis business

Foreclosures and Repossessions

A foreclosure is treated as a sale of the property. For recourse debt, any debt forgiven beyond the property’s value is cancellation-of-debt income. For nonrecourse debt, the full debt is treated as the sale price, with no separate COD income. You may receive both Form 1099-A and 1099-C.

Taxable canceled debt is reported as other income on Schedule 1. If it creates a tax bill you can’t pay, see What to Do If You Can’t Pay Your Taxes.

Get Help From Diehl CPA

Tax rules change often, and the right answer depends on your full financial picture. Diehl CPA, led by Mark Diehl, CPA, CFE, prepares returns and builds tax plans for investors, retirees and closely held businesses. Learn about our tax return preparation and investment tax planning services, or contact us to talk through your situation.

This article is general information, not tax or legal advice for your specific situation. Updated October 2026.