There are unique tax laws that apply if you have income or expenses related to working on a farm. If you operate or work on a farm, when you prepare your tax return, you must understand these tax laws.
This publication, the sixth in a series of articles on taxes for farmers, focuses on Cancellation of Debt. The previous entries covered Recordkeeping and Accounting, Income from the Sale of Farm Products, Rent Income, Agricultural Program Payments, and Income from Cooperatives.
Cancellation of Debt
In general, if a debt you owe is cancelled or forgiven, you must include the amount of the debt in your gross income for income tax purposes, unless the cancellation of debt is considered a gift or bequest. However, the cancellation or forgiveness of farm indebtedness is an exception to the general rule on including such debt in your gross income.
The following are exceptions to the general rule on cancellation of debt.
Price Reduced after Purchase
If property you purchased was financed by the seller and the seller reduces the amount of debt you owe when you are neither insolvent or in a chapter 11 bankruptcy, the amount of the debt reduction is considered a reduction in the purchase price of the property. This reduction in purchase price reduces your basis in the property.
When the payment of a debt would have been a deductible expense, you do not recognize income from a cancellation of debt.
You do not include cancelled debt in come in any of the following situations.
- The cancellation of debt occurs as a part of a chapter 11 bankruptcy case.
- The cancellation of debt occurs when you are insolvent.
- The cancellation of debt is a qualified farm debt.
- The cancellation of debt is a qualified real property business debt.
- The cancellation of debt is qualified principle residence indebtedness discharged after 2006 and before 2015.
Cancellation of debt occurs as a part of a bankruptcy case when that cancellation is granted by the court or stems from a plan approved by the court. Do not include cancelled debt in your income in the year in which the debt was cancelled as a part of a chapter 11 bankruptcy case. Instead, the amount of the cancelled debt is used to reduce your tax attributes.
Insolvency occurs when your liabilities exceed the fair market value of your assets immediately before the cancellation of debt. You can exclude cancelled debt from your income up to the amount by which you are insolvent. If the cancelled debt is more than the amount by which you are insolvent, you can treat the debt as qualified farm debt or qualified real property debt. Otherwise, you must include the difference in gross income.
Reduction of Tax Attributes
If you exclude cancelled debt from income in a bankruptcy case or while in insolvency, you must use the excluded debt to reduce certain tax attributes. You must reduce the tax attributes in the following order:
- Net operating loss (NOL)
- General business credit carryover
- Minimum tax credit
- Capital loss
- Passive activity loss and credit carryovers
- Foreign tax credits
Qualified Farm Debt
You can exclude from income a cancelled debt that is qualified farm debt owed to a qualified person. You can only use this exclusion if you were solvent when the debt was cancelled or if you are insolvent, to the extent the cancelled debt is more than the amount by which you were solvent.
Debt is considered qualified farm debt if you incurred it directly from operating a farming business and at least 50 percent of your total gross receipts from the previous three years were from your farming business.
A qualified person is a person who is actively and regularly in the business of lending money.
How can I get help preparing my tax return?
If you need help preparing your tax return, you can get that help from a tax attorney. Tax attorneys specialize in all types of tax law, including tax laws related to farming. If you need help preparing your tax return or getting answers to tax questions, a tax attorney is whom you need to speak with.
You can talk to a tax attorney by completing the form below or by calling the telephone number located at the top of this web site. A tax attorney will get in touch with you to give you the help you need. The initial conversation is free of charge, and all conversations with a tax attorney are completely confidential. Therefore, you have every reason to get in contact with a tax attorney to get the answers to your questions you need today.
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Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.