Blank Irs 4681 PDF Template

Jan 26, 2022

Contents

Future Developments

For the latest information about developments related to Pub. 4681, such as legislation enacted after it was published, go to IRS.gov/ Pub4681.

What’s New

Discharge of student loan debt. If your stu- dent loan debt was discharged, in whole or in part, after December 31, 2020, the amount of debt that was discharged may be nontaxable. See Student Loans, later.

Discharge of qualified principal residence indebtedness before 2026. Qualified princi- pal residence indebtedness can be excluded from income for discharges before January 1, 2026.

Reminder

Photographs of missing children. The Inter- nal Revenue Service is a proud partner with the National Center for Missing & Exploited Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 800-THE-LOST (800-843-5678) if you recog- nize a child.

Introduction

This publication explains the federal tax treat- ment of canceled debts, foreclosures, repos- sessions, and abandonments.

Generally, if you owe a debt to someone else and they cancel or forgive that debt for less than its full amount, you are treated for income tax purposes as having income and may have to pay tax on this income.

Note. This publication generally refers to debt that is canceled, forgiven, or discharged for less than the full amount of the debt as “can- celed debt.”

Sometimes a debt, or part of a debt, that you don't have to pay isn't considered canceled debt. These exceptions are discussed later un- der Exceptions.

Sometimes a canceled debt may be exclu- ded from your income. But if you do exclude canceled debt from income, you may be re- quired to reduce your “tax attributes.” These ex- clusions and the reduction of tax attributes as- sociated with them are discussed later under Exclusions.

Foreclosure and repossession are remedies that your lender may exercise if you fail to make payments on your loan and you have previously granted that lender a mortgage or other security interest in some of your property. These rem- edies allow the lender to seize or sell the prop- erty securing the loan. When your property is foreclosed upon or repossessed and sold, you are treated as having sold the property and you may recognize taxable gain. Whether you also recognize income from canceled debt depends in part on whether you are personally liable for the debt and in part on whether the outstanding loan balance is more than the fair market value (FMV) of the property. Figuring your gain or loss and income from canceled debt arising from a foreclosure or repossession is discussed later under Foreclosures and Repossessions.

Generally, you abandon property when you voluntarily and permanently give up possession and use of property you own with the intention of ending your ownership but without passing it on to anyone else. Figuring your gain or loss and income from canceled debt arising from an abandonment is discussed later under Aban- donments.

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Useful Items

You may want to see:

Publication

225 Farmer's Tax Guide

334 Tax Guide for Small Business (For Individuals Who Use Schedule C)

1099-C Cancellation of Debt

1099-DIV Dividends and Distributions

3800 General Business Credit

Common Situations

Covered in This

Publication

The sections of this publication that apply to you depend on the type of debt canceled, the tax attributes you have, and whether or not you continue to own the property that was subject to the debt. Some examples of common circum- stances are provided in the following para- graphs to help guide you through this publica- tion. These examples don't cover every situation but are intended to provide general guidance for the most common situations.

Nonbusiness credit card debt cancellation. If you had a nonbusiness credit card debt can- celed, you may be able to exclude the canceled debt from income if the cancellation occurred in a title 11 bankruptcy case or you were insolvent immediately before the cancellation. You should read Bankruptcy or Insolvency under Exclusions in chapter 1 to see if you can ex- clude the canceled debt from income under one of those provisions. If you can exclude part or all of the canceled debt from income, you also should read Bankruptcy and Insolvency under Reduction of Tax Attributes in chapter 1.

Personal vehicle repossession. If you had a personal vehicle repossessed and disposed of by the lender during the year, you will need to determine your gain or nondeductible loss on the disposition. This is explained in chapter 2. If the lender also canceled all or part of the re- maining amount of the loan, you may be able to exclude the canceled debt from income if the cancellation occurred in a title 11 bankruptcy case or you were insolvent immediately before the cancellation. You should read Bankruptcy or Insolvency under Exclusions in chapter 1 to see if you can exclude the canceled debt from in- come under one of those provisions. If you can exclude part or all of the canceled debt from in- come, you should also read Bankruptcy and In- solvency under Reduction of Tax Attributes in chapter 1.

Main home foreclosure or abandonment. If a lender foreclosed on your main home during the year, you will need to determine your gain or loss on the foreclosure. Foreclosures are ex- plained in chapter 2 and abandonments are ex- plained in chapter 3.

Main home loan modification (workout agreement). If a lender agreed to a mortgage loan modification (a “workout”) in 2020 that in- cluded a reduction in the principal balance of the loan in 2021, you should read Qualified Principal Residence Indebtedness under Exclu- sions in chapter 1 to see if you can exclude part or all of the canceled debt from income. If you can exclude part or all of the canceled debt from income, you should also read Qualified Principal Residence Indebtedness under Re- duction of Tax Attributes in chapter 1.

Publication 4681 (2021)

1.

Canceled Debts

This chapter discusses the tax treatment of canceled debts.

General Rules

Generally, if a debt for which you are personally liable is forgiven or discharged for less than the full amount owed, the debt is considered can- celed in whatever amount it remained unpaid. There are exceptions to this rule, discussed un- der Exceptions, later. Generally, you must in- clude the canceled debt in your income. How- ever, you may be able to exclude the canceled debt. See Exclusions, later.

Example. John owed $1,000 to Mary. Mary agreed to accept and John paid $400 in satis- faction of the entire debt. John has canceled debt of $600.

Example. Margaret owed $1,000 to Henry. Henry and Margaret agreed that Margaret would provide Henry with services (instead of money) in full satisfaction of the debt. Margaret doesn't have canceled debt. Instead, she has income from services.

A debt includes any indebtedness:

•For which you are liable, or

•Subject to which you hold property.

Debt for which you are personally liable is re- course debt. All other debt is nonrecourse debt.

If you aren't personally liable for the debt, you don't have ordinary income from the can- cellation of debt unless you retain the collateral and either:

•The lender offers a discount for the early payment of the debt, or

•The lender agrees to a loan modification that results in the reduction of the principal balance of the debt.

See Discounts and Loan Modifications, later.

However, upon the disposition of the prop- erty securing a nonrecourse debt, the amount realized includes the entire unpaid amount of the debt, not just the FMV of the property. As a result, you may realize a gain or loss if the out- standing debt immediately before the disposi- tion is more or less than your adjusted basis in the property. For more details on figuring your gain or loss, see chapter 2 of this publication or see Pub. 544.

There are several exceptions and exclu- sions that may result in part or all of a canceled debt being nontaxable. See Exceptions and Ex- clusions, later. You must report any taxable canceled debt as ordinary income on:

•Schedule 1 (Form 1040), line 8c, if the debt is a nonbusiness debt;

•Schedule C (Form 1040), line 6, if the debt is related to a nonfarm sole proprietorship;

•Schedule E (Form 1040), line 3, if the debt is related to nonfarm rental of real property;

•Form 4835, line 6, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or

•Schedule F (Form 1040), line 8, if the debt is farm debt and you are a farmer.

Form 1099-C

If you receive a Form 1099-C, that means an applicable entity has reported an identifiable event to the IRS regarding a debt you owe. For information on the reasons an applicable entity files Form 1099-C, see Identifiable event codes, later. Unless you meet one of the exceptions or exclusions discussed later, this canceled debt is ordinary income and must be reported on the appropriate form discussed above.

If you had a student loan that was dis- TIP charged after December 31, 2020, and the amount of the discharged loan is nontaxable, you won’t receive a Form 1099-C from the lender or servicer of your student loan.

An applicable entity includes the following.

1.A financial institution.

2.A credit union.

3.Any of the following, its successor, or sub- unit of one of the following.

a.The Federal Deposit Insurance Cor- poration (FDIC).

b.The Resolution Trust Corporation (RTC).

c.The National Credit Union Administra- tion (NCUA).

d.Any other federal executive agency, including government corporations, any military department, the U.S.

Postal Service, or the Postal Rate Commission.

4.A corporate subsidiary of a financial insti- tution or credit union (if the affiliation sub- jects the subsidiary to federal or state reg- ulation).

5.A federal government agency, including a department, an agency, a court or court administrative office, or a judicial or legis- lative instrumentality.

6.Any organization of which lending money is a significant trade or business.

For more information on the applicable entities that must file a Form 1099-C, see the 2021 In- structions for Forms 1099-A and 1099-C, avail- able at IRS.gov/pub/irs-prior/i1099ac--2021.pdf.

Identifiable event codes. Box 6 of Form 1099-C should indicate the reason the creditor filed this form. The codes shown in box 6 are explained next. Also, see the chart after the ex- planation for a quick reference guide for the co- des used in box 6.

Code A—Bankruptcy. Code A is used to identify cancellation of debt as a result of a title 11 bankruptcy case. See Bankruptcy, later.

Code B—Other judicial debt relief. Code B is used to identify cancellation of debt as a re- sult of a receivership, foreclosure, or similar fed- eral or state court proceeding other than bank- ruptcy.

Code C—Statute of limitations or expira- tion of deficiency period. Code C is used to identify cancellation of debt either when the statute of limitations for collecting the debt ex- pires or when the statutory period for filing a claim or beginning a deficiency judgment pro- ceeding expires. In the case of the expiration of a statute of limitations, an identifiable event oc- curs only if and when your affirmative defense of the statute of limitations is upheld in a final judgment or decision in a judicial proceeding, and the period for appealing the judgment or decision has expired.

Code D—Foreclosure election. Code D is used to identify cancellation of debt when the creditor elects foreclosure remedies that statu- torily end or bar the creditor's right to pursue collection of the debt. This event applies to a mortgage lender or holder who is barred from pursuing debt collection after a power of sale in the mortgage or deed of trust is exercised.

Code E—Debt relief from probate or similar proceeding. Code E is used to identify cancellation of debt as a result of a probate court or similar legal proceeding.

Code F—By agreement. Code F is used to identify cancellation of debt as a result of an agreement between the creditor and the debtor to cancel the debt at less than full considera- tion.

Code G—Decision or policy to discon- tinue collection. Code G is used to identify cancellation of debt as a result of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. For pur- poses of this identifiable event, a defined policy includes both a written policy and the creditor's established business practice.

Code H—Other actual discharge before identifiable event. Code H is used to identify an actual cancellation of debt that occurs before any of the identifiable events described in co- des A through G.

Form 1099-C Reference Guide for Box 6 Identifiable Event Codes

A Bankruptcy

B Other judicial debt relief

CStatute of limitations or expiration of deficiency period

D Foreclosure election

EDebt relief from probate or similar proceeding F By agreement

G Decision or policy to discontinue collection

H Other actual discharge before identifiable event

Even if you didn't receive a Form

!1099-C, you must report canceled debt CAUTION as gross income on your tax return un- less one of the exceptions or exclusions descri- bed later applies.

Amount of canceled debt. The amount in box 2 of Form 1099-C may represent some or

all of the debt that has been canceled. The amount in box 2 will include principal and may include interest and other nonprincipal amounts (such as fees or penalties). Unless you meet one of the exceptions or exclusions discussed later, the amount of the debt that has been can- celed is ordinary income and must be reported on the appropriate form, as discussed earlier.

Interest included in canceled debt. If any in- terest is included in the amount of canceled debt in box 2, it will be shown in box 3. Whether the interest portion of the canceled debt must be included in your income depends on whether the interest would be deductible if you paid it. See Deductible Debt under Exceptions, later.

Persons who each receive a Form 1099-C showing the full amount of debt. If you and another person were jointly and severally liable for a canceled debt, each of you may get a Form 1099-C showing the entire amount of the canceled debt. However, you may not have to report that entire amount as income. The amount, if any, you must report depends on all the facts and circumstances, including:

•State law,

•The amount of debt proceeds each person received,

•How much of any interest deduction from the debt was claimed by each person,

•How much of the basis of any co-owned property bought with the debt proceeds was allocated to each co-owner, and

•Whether the canceled debt qualifies for any of the exceptions or exclusions descri- bed in this publication.

See Example 3 under Insolvency, later.

Discounts and Loan

Modifications

If a lender discounts (reduces) the principal bal- ance of a loan because you pay it off early, or agrees to a loan modification (a “workout”) that includes a reduction in the principal balance of a loan, the amount of the discount or the amount of principal reduction is canceled debt. However, if the debt is nonrecourse and you didn't retain the collateral, you don't have can- cellation of debt income. The amount of the canceled debt must be included in income un- less one of the exceptions or exclusions descri- bed later applies. For more details, see Excep- tions and Exclusions, later.

Sales or Other Dispositions (Such as Foreclosures and Repossessions)

Recourse debt. If you owned property that was subject to a recourse debt in excess of the FMV of the property, the lender's foreclosure or repossession of the property is treated as a sale or disposition of the property by you and may result in your realization of gain or loss. The gain or loss on the disposition of the property is measured by the difference between the FMV of the property at the time of the disposition and your adjusted basis (usually your cost) in the property. The character of the gain or loss (such

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as ordinary or capital) is determined by the character of the property. If the lender forgives all or part of the amount of the debt in excess of the FMV of the property, the cancellation of the excess debt may result in ordinary income. The ordinary income from the cancellation of debt (the excess of the canceled debt over the FMV of the property) must be included in your gross income reported on your tax return unless one of the exceptions or exclusions described later applies. For more details, see Exceptions and Exclusions, later.

Nonrecourse debt. If you owned property that was subject to a nonrecourse debt in excess of the FMV of the property, the lender's foreclo- sure on the property doesn't result in ordinary income from the cancellation of debt. The entire amount of the nonrecourse debt is treated as an amount realized on the disposition of the prop- erty. The gain or loss on the disposition of the property is measured by the difference between the total amount realized (the entire amount of the nonrecourse debt plus the amount of cash and the FMV of any property received) and your adjusted basis in the property. The character of the gain or loss is determined by the character of the property.

More information. See chapter 2 of this publi- cation and Pubs. 523, 544, and 551 for more details.

Abandonments

Recourse debt. If you abandon property that secures a debt for which you are personally lia- ble (recourse debt) and the debt is canceled, you will realize ordinary income equal to the canceled debt. You must report this income on your tax return unless one of the exceptions or exclusions described later applies. For more details, see Exceptions and Exclusions, later. This income is separate from any amount real- ized from the abandonment of the property. For more details, see chapter 3.

Nonrecourse debt. If you abandon property that secures a debt for which you aren't person- ally liable (nonrecourse debt), you may realize gain or loss but won't have cancellation of in- debtedness income.

Stockholder Debt

If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution. For more information, see Pub. 542.

Exceptions

There are several exceptions to the require- ment that you include canceled debt in income. These exceptions apply before the exclusions discussed later and don't require you to reduce your tax attributes.

Gifts, Bequests, Devises, and Inheritances

In most cases, you don't have income from can- celed debt if the debt is canceled as a gift, be- quest, devise, or inheritance.

Student Loans

Generally, if you are responsible for making loan payments, and the loan is canceled or re- paid by someone else, you must include the amount that was canceled or paid on your be- half in your gross income for tax purposes. However, in certain circumstances, you may be able to exclude amounts from gross income as a result of:

•Student loan cancellation due to meeting certain work requirements,

•Student loan cancellation after December 31, 2020, and before January 1, 2026, for loans provided expressly for post-secon- dary educational expenses, or

•Student loan repayment assistance.

Student loan cancellation due to meeting certain work requirements. If your student loan is canceled in part or in whole in 2021, you may not have to include the canceled debt in your income. To exclude canceled student loan debt from your income, your loan must have been made by a qualified lender to assist you in attending an eligible educational institution. In addition, the cancellation must be after Decem- ber 31, 2020, and before January 1, 2026, or pursuant to a provision in the loan that all or part of the debt will be canceled if you work:

•For a certain period of time,

•In certain professions, and

•For any of a broad class of employers.

The cancellation of your loan won’t

!qualify for tax-free treatment if it is can- CAUTION celed because of services you per- formed for the educational institution that made the loan or other organization that provided the funds. See Exception, later.

Eligible educational institution. This is an educational institution that maintains a regu- lar faculty and curriculum and normally has a regularly enrolled body of students in attend- ance at the place where it carries on its educa- tional activities.

Qualified lenders. These include the fol- lowing.

1.The United States, or an instrumentality or agency thereof.

2.A state, territory, or possession of the Uni- ted States; or the District of Columbia; or any political subdivision thereof.

3.A public benefit corporation that is tax ex- empt under section 501(c)(3); and that has assumed control of a state, county, or municipal hospital; and whose employees are considered public employees under state law.

4.An eligible educational institution, if the loan is made:

Publication 4681 (2021)

a.As part of an agreement with an entity described in (1), (2), or (3) under which the funds to make the loan were provided to the educational insti- tution; or

b.Under a program of the educational institution that is designed to encour- age its students to serve in occupa- tions with unmet needs or in areas with unmet needs where the services provided by the students (or former students) are for or under the direc- tion of a governmental unit or a tax-exempt section 501(c)(3) organi- zation.

Special rule for student loan discharges for 2021 through 2025. Discharges of student loans, in whole or in part, after December 31, 2020, and before January 1, 2026, of any loan provided expressly for post-secondary educa- tional expenses, provided to the educational in- stitution or directly to you may not be taxable if the loan was made, insured, or guaranteed by:

1.A qualified lender (described above),

2.Any private education loan defined in sec- tion 140(a)(7) of the Truth in Lending Act,

•An eligible educational institution (de- scribed earlier) pursuant to an agree- ment under which the funds from the loan were provided to such educa- tional organization, or

•An educational organization which is designed to encourage its students to serve in occupations with unmet needs or in areas with unmet needs and under which the services provi- ded by the students (or former stu- dents) are for or under the direction of a governmental unit or are for or un- der an organization described in a charitable tax-exempt organization.

3.Any loan made by an educational or chari- table tax-exempt organization to refinance a loan to an individual to assist the individ- ual in attending any such educational or- ganization but only if the refinancing loan is pursuant to a program of the refinancing organization which is described in 2 above.

The cancellation of your loan won’t

!qualify for tax free treatment if it is can- CAUTION celed because of services you per- formed for the educational institution that made the loan or other organization that provides the funds. See Exception, later.

Section 501(c)(3) organization. This is any corporation, community chest, fund, or foundation organized and operated exclusively for one or more of the following purposes.

•Charitable.

•Religious.

•Educational.

•Scientific.

•Literary.

•Testing for public safety.

•Fostering national or international amateur sports competition (but only if none of its activities involve providing athletic facilities or equipment).

Publication 4681 (2021)

•The prevention of cruelty to children or ani- mals.

Exception. In most cases, the cancellation of a student loan made by an educational insti- tution because of services you performed for that institution or another organization that pro- vided the funds for the loan must be included in gross income on your tax return.

Refinanced loan. If you refinanced a stu- dent loan with another loan from an eligible ed- ucational institution or a tax-exempt organiza- tion, that loan may also be considered as made by a qualified lender. The refinanced loan is considered made by a qualified lender if it’s made under a program of the refinancing organ- ization that is designed to encourage students to serve in occupations with unmet needs or in areas with unmet needs where the services re- quired of the students are for or under the direc- tion of a governmental unit or a tax-exempt sec- tion 501(c)(3) organization.

Student loan repayment assistance. Stu- dent loan repayments made to you are tax free if you received them for any of the following.

•The National Health Service Corps (NHSC) Loan Repayment Program.

•A state education loan repayment program eligible for funds under the Public Health Service Act.

•Any other state loan repayment or loan for- giveness program that is intended to pro- vide for the increased availability of health services in underserved or health profes- sional shortage areas (as determined by such state).

You can’t deduct the interest you paid

!on a student loan to the extent pay- CAUTION ments were made through your partici- pation in any of the above programs.

Deductible Debt

If you use the cash method of accounting, you don't realize income from the cancellation of debt if the payment of the debt would have been a deductible expense. This exception ap- plies before the price reduction exception dis- cussed next.

Example. In December 2020, you get ac- counting services for your farm on credit. In early 2021, you have trouble paying your farm debts and 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 can- celed debt in income because payment of the debt would have been deductible as a business expense in 2021.

•Accrual method. Unless another exception or exclusion applies, you must include the canceled debt in ordinary income because the expense was deductible in 2020 when you incurred the debt.

Price Reduced After

Purchase

If debt you owe the seller for the purchase of property is reduced by the seller at a time when you aren't insolvent and the reduction doesn't occur in a title 11 bankruptcy case, the reduc- tion doesn't result in cancellation of debt in- come. However, you must reduce your basis in the property by the amount of the reduction of your debt to the seller. The rules that apply to bankruptcy and insolvency are explained in Ex- clusions next.

Exclusions

After you have applied any exceptions to the general rule that a canceled debt is included in your income, there are several reasons why you might still be able to exclude a canceled debt from your income. These exclusions are ex- plained next. If a canceled debt is excluded from your income, it is nontaxable. In most ca- ses, however, if you exclude canceled debt from income under one of these provisions, you must also reduce your tax attributes (certain credits, losses, and basis of assets) as ex- plained later under Reduction of Tax Attributes.

Bankruptcy

Debt canceled in a title 11 bankruptcy case isn't included in your income. A title 11 bankruptcy case is a case under title 11 of the United States Code (including all chapters in title 11 such as chapters 7, 11, and 13). You must be a debtor under the jurisdiction of the court and the cancellation of the debt must be granted by the court or occur as a result of a plan approved by the court.

You don’t qualify for the bankruptcy exclu- sion by being an owner of, or a partner in a part- nership that owns, a grantor trust or disregar- ded entity that is a debtor in a title 11 bankruptcy case. You must be a debtor in a title 11 bankruptcy case to qualify for this exclusion.

How to report the bankruptcy exclusion. To show that your debt was canceled in a bank- ruptcy case and is excluded from income, at- tach Form 982 to your federal income tax return and check the box on line 1a. Lines 1b through 1e don't apply to a cancellation that occurs in a title 11 bankruptcy case. Enter the total amount of debt canceled in your title 11 bankruptcy case on line 2. You must also reduce your tax attributes in Part II of Form 982 as explained un- der Reduction of Tax Attributes, later.

Insolvency

Don't include a canceled debt in income to the extent that you were insolvent immediately be- fore the cancellation. You don’t qualify for the insolvency exclusion by being an owner of, or a partner in a partnership that owns, a grantor trust or disregarded entity that is insolvent. You must be insolvent to qualify for this exclusion. You were insolvent immediately before the can- cellation to the extent that the total of all of your

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2.Any net capital loss for 2021 and any capi- tal loss carryover to 2021.

3.Any passive activity loss carryover from 2021.

4.Three times the sum of any:

a.General business credit carryover to or from 2021,

b.Minimum tax credit available as of the beginning of 2022,

c.Foreign tax credit carryover to or from 2021, and

d.Passive activity credit carryover from 2021.

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

How to report the qualified farm indebted- ness exclusion. To show that all or part of your canceled debt is excluded from income because it is qualified farm debt, check the box on line 1c of Form 982 and attach it to your Form 1040 or 1040-SR. On line 2 of Form 982, include the amount of the qualified farm debt canceled, but not more than the exclusion limit (explained earlier). You must also reduce your tax attributes in Part II of Form 982 as explained under Reduction of Tax Attributes, later.

Example 1—only qualified farm indebt- edness exclusion applies. In 2021, Chuck was released from his obligation to pay a $10,000 debt that was incurred directly in con- nection with his trade or business of farming. Chuck received a Form 1099-C from the quali- fied lender showing discharged debt of $10,000 in box 2. For his 2018, 2019, and 2020 tax years, at least 50% of Chuck's total gross re- ceipts were from the trade or business of farm- ing. Chuck's adjusted tax attributes are $5,000 and Chuck has $3,000 total adjusted basis in qualified property at the beginning of 2022. Chuck had no other debt canceled during 2021 and no other exception or exclusion relating to canceled debt income applies.

Chuck can exclude $8,000 ($5,000 of adjus- ted tax attributes plus $3,000 total adjusted ba- sis in qualified property at the beginning of 2022) of the $10,000 canceled debt from in- come. Chuck checks the box on line 1c of Form 982 and enters $8,000 on line 2. Also, Chuck completes Part II to reduce his tax attributes as explained under Reduction of Tax Attributes, later. The remaining $2,000 of canceled quali- fied farm debt is included in Chuck's income on Schedule F (Form 1040), line 8.

Example 2—both insolvency and quali- fied farm indebtedness exclusions apply. On March 2, 2021, Bob was released from his obligation to pay a $10,000 business credit card debt that was used directly in connection with his farming business. For his 2018, 2019, and 2020 tax years, at least 50% of Bob's total gross receipts were from the trade or business of farming. Bob received a 2021 Form 1099-C from the qualified lender showing discharged debt of $10,000 in box 2. The FMV of Bob's to- tal assets on March 2, 2021 (immediately be- fore the cancellation of the credit card debt), was $7,000 and Bob's total liabilities at that time

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were $11,000. Bob's adjusted tax attributes (a 2021 NOL) are $7,000 and Bob has $4,000 to- tal adjusted basis in qualified property at the be- ginning of 2022.

Bob qualifies to exclude $4,000 of the can- celed debt under the insolvency exclusion be- cause he is insolvent to the extent of $4,000 im- mediately before the cancellation ($11,000 total liabilities minus $7,000 FMV of total assets). Bob must reduce his tax attributes under the in- solvency rules before applying the rules for qualified farm debt.

Bob also qualifies to exclude the remaining $6,000 of canceled qualified farm debt. The limit on Bob's exclusion from income of can- celed qualified farm debt is $7,000, the sum of:

1.His adjusted tax attributes of $3,000 (the $7,000 NOL minus the $4,000 reduction of tax attributes required because of the $4,000 exclusion of canceled debt under the insolvency exclusion), and

2.His total adjusted basis of $4,000 in quali- fied property he held at the beginning of 2022.

Bob checks the boxes on lines 1b and 1c of Form 982 and enters $10,000 on line 2. Bob completes Part II to reduce his tax attributes as explained under Reduction of Tax Attributes, later. Bob doesn't include any of his canceled debt in income.

Example 3—no qualified farm indebted- ness exclusion when insolvent to the extent of canceled debt. The facts are the same as in Example 2, except that immediately before the cancellation, Bob was insolvent to the ex- tent of the full $10,000 canceled debt. Because the exclusion for qualified farm debt doesn't ap- ply to the extent that Bob’s insolvency (immedi- ately before the cancellation) was equal to the full amount of the canceled debt, he checks only the box on line 1b of Form 982 and enters $10,000 on line 2. Bob completes Part II to re- duce his tax attributes based on the insolvency exclusion as explained under Reduction of Tax Attributes, later. Bob doesn't include any of the canceled debt in income.

Qualified Real Property Business Indebtedness

You can elect to exclude canceled qualified real property business indebtedness from income. Qualified real property business indebtedness is debt (other than qualified farm debt) that meets all of the following conditions.

1.It was incurred or assumed in connection with real property used in a trade or busi- ness. Real property used in a trade or business doesn’t include real property de- veloped and held primarily for sale to cus- tomers in the ordinary course of business.

2.It is secured by that real property. As long as certain other requirements are met, in- debtedness that is secured by 100% of the ownership interest in a disregarded entity holding real property will be treated as in- debtedness that is secured by real prop- erty. For more information, and for the re- quirements that must be met, see

Revenue Procedure 2014-20, available at IRS.gov/irb/2014-9_IRB#RP-2014-20.

3.It was incurred or assumed:

a.Before 1993; or

b.After 1992, if the debt is either (i) qualified acquisition indebtedness (defined next), or (ii) debt incurred to refinance qualified real property busi- ness debt incurred or assumed before 1993 (but only to the extent the amount of such debt doesn't exceed the amount of debt being refinanced).

4.It is debt to which you elect to apply these rules.

Residential rental property generally TIP qualifies as real property used in a trade or business unless you also use the dwelling as a home. For more information,

see Dwelling Unit Used as a Home in Pub. 527.

Definition of qualified acquisition indebted- ness. Qualified acquisition indebtedness is:

•Debt incurred or assumed to acquire, con- struct, reconstruct, or substantially improve real property that is used in a trade or busi- ness and secures the debt; or

•Debt resulting from the refinancing of quali- fied acquisition indebtedness, to the extent the amount of the debt doesn't exceed the amount of debt being refinanced.

Other exclusions must be applied before the qualified real property business indebt- edness exclusion. This exclusion doesn't ap- ply to a cancellation of debt in a title 11 bank- ruptcy case or to the extent you were insolvent immediately before the cancellation. If qualified real property business debt is canceled in a title 11 bankruptcy case, you must apply the bank- ruptcy exclusion rather than the exclusion for canceled qualified real property business debt. If you were insolvent immediately before the cancellation of qualified real property business debt, you must apply the insolvency exclusion before applying the exclusion for canceled qualified real property business debt.

Exclusion limit. The amount of canceled qualified real property business debt you can exclude from income under this exclusion has two limits. The amount you can exclude can't be more than either:

1.The excess (if any) of the outstanding prin- cipal amount of the qualified real property business debt (immediately before the cancellation) over the FMV (immediately before the cancellation) of the business real property securing the debt, or

2.The total adjusted basis of depreciable real property you held immediately before the cancellation of the qualified real prop- erty business debt (other than depreciable real property acquired in contemplation of the cancellation).

Note. When figuring the first limit in (1) above, reduce the FMV of the business real property securing the debt (immediately before the cancellation) by the outstanding principal amount of any other qualified real property

Publication 4681 (2021)

business debt secured by that property (imme- diately before the cancellation). When figuring the second (overall) limit in (2) above, use the adjusted basis of the depreciable real property after any reductions in basis required because of the exclusion of debt canceled under the bankruptcy, insolvency, or farm debt provisions described in this publication or because of other basis adjustments that may apply to that depre- ciable property.

For more information about the basis of property, see Pub. 551.

How to elect the qualified real property business debt exclusion. You must make an election to exclude canceled qualified real prop- erty business debt from gross income. The election must be made on a timely filed federal income tax return (including extensions) for 2021 and can be revoked only with IRS con- sent. The election is made by completing Form 982 in accordance with its instructions. Attach Form 982 to your federal income tax return for 2021 and check the box on line 1d. Include the amount of canceled qualified real property busi- ness debt (but not more than the amount of the exclusion limit, explained earlier) on line 2 of Form 982. You must also reduce your tax attrib- utes in Part II of Form 982 as explained under Reduction of Tax Attributes, later.

If you timely filed your tax return without making this election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Enter “Filed pursuant to section 301.9100-2” on the amended return and file it at the same place you filed the original return.

Example—full qualified real property business indebtedness exclusion. In 2015, Curt bought a retail store for use in a business he operated as a sole proprietorship. Curt made a $20,000 down payment and financed the re- maining $200,000 of the purchase price with a bank loan. The bank loan was a recourse loan and was secured by the property. Curt used the property in his business continuously since he bought it. He had no other debt secured by that depreciable real property. In addition to the re- tail store, Curt owned depreciable equipment and furniture with an adjusted basis of $50,000.

Curt's business encountered financial diffi- culties in 2021. On September 21, 2021, the bank financing the retail store loan entered into a workout agreement with Curt under which it canceled $20,000 of the debt. Immediately be- fore the cancellation, the outstanding principal balance on the retail store loan was $185,000, the FMV of the store was $165,000, and the ad- justed basis was $210,000 ($220,000 cost mi- nus $10,000 accumulated depreciation).

The bank sent him a 2021 Form 1099-C showing discharged debt of $20,000 in box 2. Curt had no tax attributes other than the basis to reduce and didn't qualify for any exception or exclusion other than the qualified real property business debt exclusion.

Curt elects to apply the qualified real prop- erty business debt exclusion to the canceled debt. The amount of canceled qualified real property business debt that he can exclude from income is limited. The amount he can ex- clude can’t be more than either:

Publication 4681 (2021)

1.$20,000 (the excess of the $185,000 out- standing principal amount of his qualified real property business debt immediately before the cancellation over the $165,000 FMV of the business real property secur- ing the debt), or

2.$210,000 (the total adjusted basis of the depreciable real property he held immedi- ately before the cancellation).

.

Thus, Curt can exclude the entire $20,000 of canceled qualified real property business debt from income. Curt checks the box on line 1d of Form 982 and enters $20,000 on line 2. Curt must also use line 4 of Form 982 to reduce his basis in depreciable real property by the $20,000 of canceled qualified real property business debt excluded from his income as ex- plained under Reduction of Tax Attributes, later.

Qualified Principal Residence Indebtedness

Qualified principal residence indebtedness is any mortgage you took out to buy, build, or sub- stantially improve your main home. It must also be secured by your main home. Qualified princi- pal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to buy, build, or substantially improve your main home, but only up to the amount of the old mortgage principal just before the refinancing.

Example 1—qualified principal resi- dence indebtedness amount after refi- nance. In 2020, Becky bought a main home for $315,000. She took out a $300,000 mortgage loan to buy the home and made a down pay- ment of $15,000. The loan was secured by the home. Later that year, Becky took out a second mortgage loan in the amount of $50,000 that she used to add a garage to her home.

In 2021, when the outstanding principal of her first and second mortgage loans was $325,000, Becky refinanced the two loans into one loan in the amount of $400,000. The FMV of the home at the time of the refinancing was $430,000. She used the additional $75,000 debt proceeds ($400,000 new mortgage loan minus $325,000 outstanding principal balances of her first and second mortgage loans immedi- ately before the refinancing) to pay off personal credit cards and to pay college tuition for her daughter.

After the refinancing, Becky's qualified prin- cipal residence indebtedness is $325,000 be- cause the $400,000 debt resulting from the refi- nancing is qualified principal residence indebtedness only to the extent it isn't more than the old mortgage principal just before the refinancing (the $325,000 of outstanding princi- pal on Becky's first and second mortgages, which both qualified as principal residence in- debtedness).

Example 2—refinancing home equity loan used for other purposes. In 2020, Steve acquired his main home for $200,000, subject to a mortgage of $175,000. Later that year, he took out a home equity loan for

$10,000, secured by his main home, which he used to pay off personal credit cards.

In 2021, when the outstanding principal on his mortgage was $170,000, and the outstand- ing principal on his home equity loan was $9,000, he refinanced the two loans into one loan in the amount of $200,000. The FMV of the home at the time of refinancing was $210,000. He used the additional $21,000 ($200,000 new mortgage loan minus $179,000 outstanding principal balances on the mortgage and home equity loan) to cover medical expenses.

After refinancing, Steve's qualified principal residence indebtedness is $170,000 because the debt resulting from the refinancing is quali- fied principal residence indebtedness only to the extent it refinances debt that had been se- cured by the main home and was used to buy, build, or substantially improve the main home.

Main home. Your main home is the one in which you live most of the time. You can have only one main home at any one time.

Other exclusions must be applied before the qualified principal residence indebted- ness exclusion. This exclusion doesn't apply to a cancellation of debt in a title 11 bankruptcy case. If qualified principal residence indebted- ness is canceled in a title 11 bankruptcy case, you must apply the bankruptcy exclusion rather than the exclusion for qualified principal resi- dence indebtedness. If you were insolvent im- mediately before the cancellation, you can elect to apply the insolvency exclusion (as explained under Insolvency, earlier) instead of applying the qualified principal residence indebtedness exclusion. To do this, check the box on line 1b of Form 982 instead of the box on line 1e.

Exclusion limit. The maximum amount you can treat as qualified principal residence indebt- edness is $750,000 ($375,000 if married filing separately). You can't exclude canceled quali- fied principal residence indebtedness from in- come if the cancellation was for services per- formed for the lender or on account of any other factor not directly related to a decline in the value of your home or to your financial condi- tion.

Ordering rule. If only a part of a loan is quali- fied principal residence indebtedness, the ex- clusion applies only to the extent the amount canceled is more than the amount of the loan (immediately before the cancellation) that isn’t qualified principal residence indebtedness. The remaining part of the loan may qualify for an- other exclusion.

Example 3—ordering rule on cancella- tion of nonqualified principal residence debt. Ken incurred recourse debt of $800,000 when he bought his main home for $880,000. When the FMV of the property was $1 million, Ken refinanced the debt for $850,000. At the time of the refinancing, the principal balance of the original mortgage loan was $740,000. Ken used the $110,000 he obtained from the refi- nancing ($850,000 minus $740,000) to pay off his credit cards and to buy a new car.

About 2 years after the refinancing, Ken lost his job and was unable to get another job pay- ing a comparable salary. Ken's home had

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declined in value to between $600,000 and $650,000. Based on Ken's circumstances, the lender agreed to allow a short sale of the prop- erty for $620,000 and to cancel the remaining $115,000 of the outstanding $735,000 debt. Under the ordering rule, Ken can exclude only $5,000 of the canceled debt from his income under the exclusion for canceled qualified prin- cipal residence indebtedness ($115,000 can- celed debt minus the $110,000 amount of the debt that wasn't qualified principal residence in- debtedness). Ken must include the remaining $110,000 of canceled debt in income on Schedule 1 (Form 1040), line 8c (unless an- other exclusion applies).

How to report the qualified principal resi- dence indebtedness exclusion. To show that all or part of your canceled debt is excluded from income because it is qualified principal residence indebtedness, attach Form 982 to your federal income tax return and check the box on line 1e. On line 2 of Form 982, include the amount of canceled qualified principal resi- dence indebtedness, but not more than the amount of the exclusion limit (explained earlier). If you continue to own your home after a cancel- lation of qualified principal residence indebted- ness, you must reduce your basis in the home as explained under Reduction of Tax Attributes next.

Reduction of Tax

Attributes

If you exclude canceled debt from income, you must reduce certain tax attributes (but not be- low zero) by the amount excluded. Use Part II of Form 982 to reduce your tax attributes. The or- der in which the tax attributes are reduced de- pends on the reason the canceled debt was ex- cluded from income. If the total amount of canceled debt excluded from income (line 2 of Form 982) was more than your total tax attrib- utes, the total reduction of tax attributes in Part

IIof Form 982 will be less than the amount on line 2.

Qualified Principal Residence Indebtedness

If you exclude canceled qualified principal resi- dence indebtedness from income and you con- tinue to own the home after the cancellation, you must reduce the basis of the home (but not below zero) by the amount of the canceled qualified principal residence indebtedness ex- cluded from income. Enter the amount of the basis reduction on line 10b of Form 982.

For more details on determining the basis of your main home, see Pub. 523.

Bankruptcy and Insolvency

No tax attributes other than basis of per- sonal-use property. If the canceled debt you are excluding isn't excluded as qualified princi- pal residence indebtedness and you have no tax attributes other than the adjusted basis of personal-use property (see the list of seven tax attributes, later), you must reduce the basis of

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the personal-use property you held at the be- ginning of 2022 (in proportion to adjusted ba- sis). Personal-use property is any property that isn't used in your trade or business or held for investment (such as your home, home furnish- ings, and car). Include on line 10a of Form 982 the smallest of:

1.The basis of your personal-use property held at the beginning of 2022,

2.The amount of canceled nonbusiness debt (other than qualified principal residence in- debtedness) that you are excluding from income on line 2 of Form 982, or

3.The excess of the total basis of the prop- erty and the amount of money you held im- mediately after the cancellation over your total liabilities immediately after the can- cellation.

For more information about the basis of property, see Pub. 551.

Example. In 2020, Mya bought a car for personal use. The cost of the car was $12,000. Mya put down $2,000 and took out a loan of $10,000 to buy the car. The loan was a re- course loan, meaning that Mya was personally liable for the full amount of the debt.

On December 7, 2021, when the balance of the loan was $8,500, the lender repossessed and sold the car because Mya had stopped making payments on the loan. The FMV of the car was $7,000 at the time the lender repos- sessed and sold it. The lender applied the $7,000 it received on the sale of the car against Mya's loan and forgave the remaining loan bal- ance of $1,500 ($8,500 outstanding balance im- mediately before the repossession minus the $7,000 FMV of the car).

Mya's only other assets at the time of the cancellation are the furniture in her apartment which has a basis of $5,000 and an FMV of $3,000; jewelry with a basis of $500 and an FMV of $1,000; and a $600 balance in her sav- ings account. Thus, the FMV of Mya's total as- sets immediately before the cancellation was $11,600 ($7,000 car plus $3,000 furniture plus $1,000 jewelry plus $600 savings). Mya also had an outstanding student loan balance of $6,000 immediately before the cancellation, bringing her total liabilities at that time to $14,500 ($8,500 balance on car loan plus $6,000 student loan balance). Other than the car, which was repossessed, Mya held all of these assets at the beginning of 2022. The FMV and basis of the assets remained the same at the beginning of 2022.

Mya received a 2021 Form 1099-C showing $1,500 in box 2 (amount of debt that was can- celed) and $7,000 in box 7 (FMV of the prop- erty). Mya can exclude all $1,500 of canceled debt from income because at the time of the cancellation, she was insolvent to the extent of $2,900 ($14,500 of total liabilities immediately before the cancellation minus $11,600 FMV of total assets at that time).

Mya checks box 1b on Form 982 and enters $1,500 on line 2. She enters $100 on line 10a, the smallest of:

1.The $5,500 basis of her personal-use property held at the beginning of 2022 ($5,000 furniture plus $500 jewelry),

2.The $1,500 nonbusiness debt she is ex- cluding from income on line 2 of Form 982, or

3.The $100 excess of the total basis of the property and the amount of money Mya held immediately after the cancellation over her total liabilities at that time ($5,500 basis of property held immediately after the cancellation plus $600 savings minus $6,000 student loan).

Mya must reduce (by one dollar for each dollar of excluded canceled debt) her basis in each item of property she holds at the begin- ning of 2022 in proportion to her total adjusted basis in all her property. The total reduction, however, can't be more than (3) above—the $100 excess of her total adjusted basis and the money she held after the cancellation over her total liabilities after the cancellation. See the ba- sis attribute under All other tax attributes next.

Thus, she reduces her basis as follows.

1.The furniture's basis is 91% of her total ad- justed basis ($5,000 divided by $5,500), so she reduces it by $91 (the $100 excess in (3) multiplied by 0.91).

2.The jewelry’s basis is 9% of her total ad- justed basis ($500 divided by $5,500), so she reduces it by $9 (the $100 excess in

(3) multiplied by 0.09).

All other tax attributes. If the canceled debt is excluded by reason of the bankruptcy or in- solvency exclusion, you must use the excluded debt to reduce the following tax attributes (but not below zero) in the order listed unless you elect to reduce the basis of depreciable prop- erty first, as explained later. Reduce your tax at- tributes after you figure your income tax liability for 2021.

1.Net operating loss (NOL). First reduce any 2021 NOL and then reduce any NOL carryover to 2021 (after taking into ac- count any amount used to reduce 2021 taxable income) in the order of the tax years from which the carryovers arose, starting with the earliest year. Reduce the NOL or carryover by one dollar for each dollar of excluded canceled debt.

2.General business credit carryover. Re- duce the credit carryover to or from 2021. Reduce the credit carryovers to 2021 in the order in which they are taken into ac- count for 2021. For more information on the credit ordering rules for 2021, see the Instructions for Form 3800. Reduce the carryover by 331/3 cents for each dollar of excluded canceled debt.

3.Minimum tax credit. Reduce the mini- mum tax credit available at the beginning of 2022. Reduce the credit by 331/3 cents for each dollar of excluded canceled debt.

4.Net capital loss and capital loss carry- overs. First reduce any 2021 net capital loss and then any capital loss carryover to 2021 (after taking into account any amount used to reduce 2021 taxable in- come) in the order of the tax years from which the carryovers arose, starting with the earliest year. Reduce the net capital

Publication 4681 (2021)