Trying to decide between bankruptcy and debt settlement as the better path to financial health?
Own a home?
Here’s the killer reason why bankruptcy alone protects you from a serious tax consequence down the road.
Debt forgiven outside of bankruptcy gets deducted from the basis of your home. Result: more potentially taxable capital gains on sale.
Here’s the backstory and the low down on the exception to the exception that protects your home from a tax hit in the future.
Tax consequences of forgiven debt
When choosing between bankruptcy and settling your debts outside of the bankruptcy court, an advantage to bankruptcy has always been the favorable tax treatment of forgiven debt.
Debt forgiven or cancelled in bankruptcy is not added to taxable income. IRC 108
You may receive a 1099 form showing the forgiven debt, but by filing Form 982, you claim your right to exclude the forgiven debt from your income.
By contrast, make a deal with your creditors to take, say, 1/3 of what you owe in full settlement, and Uncle Sam treats the 2/3 of the debt that was cancelled as if you received it as income. Taxable income. Ouch! [Read more…]