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Columns: Tax Talk
George Saenz, CPA Expert: George Saenz, CPA
Tax Talk
Owing IRS for canceled debt
Tax Talk

Owing IRS for canceled debt
 

Dear Tax Talk:
Can a charged-off debt be considered income? I had a vehicle that was stolen and found totaled. The lien holder says I owe the balance of the loan even though I had insurance. The IRS has notified me that because the lien holder charged off the debt, then it is considered income that I did not record. I never received any letter from the lien holder stating this debt or the charge off. How can I keep this from becoming a debt to the IRS? Please help. Thanks.
--Ellen

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Dear Ellen,
Being ripped off is bad enough, but owing IRS taxes as a result is a slap in the face. Most likely, the value of the car was less than the loan balance at the time of the theft and hence you ended up owing the bank the difference. Since you didn't pay the bank, you have a canceled debt. Most likely you're personally liable for the canceled portion of the debt so it could be considered income to you. Generally you can only exclude this canceled debt if it was otherwise deductible or if you are insolvent.

A theft loss is deductible to the extent of the lesser of the automobile's cost or fair market value less any insurance reimbursement. Since the insurance presumably reimbursed you for the car's value, you do not have a deductible loss.

Most likely the lender discharged the debt because you did not have sufficient assets to repay it. Hence you may be able to claim the insolvency exclusion.

You're insolvent to the extent that your debts immediately prior to the cancellation exceed the value of your assets. In determining insolvency, the value of your assets is determined under state law as it applies to bankruptcy filings. So if your state excluded the value of your home from bankruptcy, its value would be excluded in determining if you're insolvent. Use Form 982 to claim insolvency with the IRS.

If you can't claim insolvency, you may be stuck owing the IRS even though you probably lost on the whole deal. The law considers debt discharged in excess of the value of assets as income apart from the sale or exchange of that asset.

Bankrate.com's corrections policy-- Posted: August 2, 2007
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