If you can demonstrate that you were insolvent at the time the debt was cancelled, you may not have to pay any tax on Cancellation of Debt income.
From @MichaelDC
A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may be excluded as income under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent
However, the debt cancellation must be reported and you must claim that you're insolvent on your return. The cancelled debt will then become excluded from income.
If you are reporting any type of debt cancellation other than qualified principal residence exclusion that TurboTax handles, we generally recommend using the CD/Download version of TurboTax Deluxe or a higher edition. With either of these versions, you'll be able to easily make a notation regarding your solvency.
If you started your 2020 return in TurboTax Online and want to switch to the TurboTax download/cd version, click here.
Note: if already paid for TurboTax online, contact our support representative; otherwise proceed with the desktop purchase.
Once you have the Download/CD version, there are four steps to claim your exclusion.
- Enter Form 1099-C
- Create the Insolvency Worksheet
- Check entries on Canceled Debt Worksheet
- Check Form 982
1. Enter Form 1099-C
1. Open (continue) your return.
2. In the TurboTax program, search for 1099-C or 1099C (lower-case works also) and then click the "Jump to" link in the search results.
3. Select the type of cancelled debt (main home or other) and then click Continue.
4. Follow the onscreen instructions to enter information from your 1099-C.
It will say that "Your Debt is Taxable", however, the following workaround will exclude it from income.
2. Create the Insolvency Worksheet
Click Forms in the upper right corner of your screen
Click "Open Form” (button on the top Left).
In the “Type a Form Name” box at the top, type “insolvency”.
Select the form that pops up and click Open Form.
Fill out the form which will give you the Amount of insolvency at the end on Line 7.
3. Check entries on the Canceled Debt Worksheet
In "Form Mode", scroll in the left column to Canceled Debt (Copy 1) and Click. It will open the form.
Scroll to Part VIII - Exclusion for Insolvency
On Line 53 "Were you insolvent? Make sure it's checked Yes
On Line 54 "Amount of Insolvency" carried from Line 7 of Insolvency Worksheet.
On Line 57 "Amount Excluded"
If your total liabilities exceeded the total FMV of your assets at the time of the cancellation, you may exclude the canceled debt to that extent. Complete the "Statement of Insolvency" to compute and document the amount of insolvency.
4. Check Form 982
In "Form Mode", scroll in the left column to Form 982 and Click. It will open the form.
Make sure that Box 1b is checked to exclude your income to the extent insolvent.
Once Form 982 is complete you will want to review Form 1040 "other Income" line. This is the amount of your cancelled debt that's taxable. If you were insolvent, it should be zero or at least less than the total cancelled debt from the 1099-C
