Any discussion about the tax risks of loan modifications has to start with the fact that between 2007 and 2010, the United States experienced a subprime mortgage crisis that contributed to a world-wide financial recession that threatened to collapse our economy. In response, the federal government introduced and widely publicized several federal mortgage loan modification programs — each aimed at assisting distressed homeowners by modifying or refinancing mortgage loans that became unaffordable.

If you’re unfamiliar with it, loan modification is the renegotiation of the terms of an existing loan. It may involve a reduction in principal or interest rate, an extension of the length of time for repayment, or a change in loan type (from adjustable rate to a fixed rate, for instance). It can also result in a cancellation of debt (COD) — a situation in which the total amount you pay the lender is less than that required under the original agreement.

From the borrowers’ perspective, a cancellation of debt is a great deal. The only drawback is that the Internal Revenue Service (IRS) is likely to treat the COD as taxable income, which can come as a nasty surprise when tax season hits. Unfortunately, it’s likely to surprise more people this coming tax season because of the increase in loan modifications during the COVID-19 pandemic.

One of our responsibilities here at SWC is to protect our clients from nasty surprises. If you received a 1099-C from your lender or you’ve had a loan modified or are in the process of doing so, we want you to know what to expect and be prepared. One way to do that is by helping you answer common questions like the ones that appear below.

Is My Cancelled Debt Taxable? Answer These Four Questions

According to the IRS, “In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable, and you must report the canceled debt on your tax return for the year the cancellation occurs.”

On its surface, that seems simple enough, but when you start digging into the details, determining whether a certain loan modification generated a taxable cancellation of debt (COD) can be challenging. If you renegotiated the terms of a loan, you can determine whether it resulted in taxable COD income by answering these four questions: Continue reading… Continue reading… Continue reading…