If You Have a Personal Loan Forgiven This Year, You May Have to Pay Taxes on It

Your debt was forgiven? Congratulations! Now get ready to pay taxes.

Have a personal loan? If you are lucky enough to have it forgiven, that may be a huge relief. But you may not be out of the woods yet. Did you know if it is forgiven you have to pay taxes on it?

It's important to understand what your tax obligations are if the loan is forgiven. If the money you borrowed becomes cancellation of debt (COD) income, you must report this income when filing your taxes for the year in which the loan was forgiven. Let's take a closer look at how personal loans and taxes intersect.

Cancellation of debt (COD)

When a lender decides to forgive or not pursue repayment on debt that you owe, this forgone debt is known as cancellation of debt (COD) income. This means that if you didn't pay the full amount owed, the difference between what you did pay and what was owed will be considered taxable income at the end of the year. When COD income occurs, you must report it on your taxes as regular income for the year in which it was forgiven.

So if you have taken out a personal loan and are expecting it to be forgiven, make sure you're prepared to account for this extra income when filing your taxes next year. For example, if you had a loan balance of $10,000 but only paid back $8,000 before it was discharged by the lender, then $2,000 would become taxable COD income in that tax year.

Exceptions to the rule

It is important to note that COD income does not always apply just because a loan was forgiven. There are certain exceptions that allow borrowers to avoid reporting it on their taxes. These include amounts canceled as gifts or inheritances, certain loan forgiveness programs, qualified real property business loans, qualified principal residence indebtedness, and certain other types of exemptions defined by IRS regulations. These exclusions include insolvency or bankruptcy events.

If any of these apply to you or your situation, then you may not need to pay tax on it. These exclusions apply depending on the specifics of your situation, so you may want to contact a tax professional for more information. If none of these exclusions apply to you, then all canceled debt must still be reported as taxable COD income at the end of the year.

If you have COD income due to debt cancellation for less than what was owed, then that amount needs to be reported as taxable income on your tax return for the year it occurred. Knowing what your tax obligations will be can help you avoid trouble with the IRS. Knowing which exclusion, if any, you qualify for can help you save money on taxes. As always, double check with a financial professional before making any decisions related to reporting COD.