Irs Form 4681 – Fill Out and Use This PDF

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).

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•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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