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The Insolvency Exception for Cancellation of Debt

Posted by attorney Henry Lively
Filed under: Debt

When you have cancellation of debt income (COD) there are several exceptions that you can use to avoid being taxed on the income. Cancellation of debt income occurs when you have a debt that is settled for less than the amount that you borrowed. Since you did not pay tax on the money when it was borrowed, it is income when you do not pay it back.

However, there are exceptions to the recognition of this income. If you are bankrupt you do not have to claim the income, if the debt is non-recourse you do not have to claim the income, if it is your personal residence that secured the debt their are special rules and you may not have to claim the income, and finally if you are insolvent you may not have to claim the income.

You are insolvent if your debt exceeds your assets. If this is the case you do not have to claim the COD to the extent that your debt exceeds your assets. You can determine if you qualify by preparing a current balance sheet whereby you list the fair market value of all of your assets, and then the current balance of all your debt. If the debt exceeds the assets you qualify.

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