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Canceled Mortgage Debt and Taxes

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Bankruptcy Exclusion for Canceled Debts

Canceled debts can be excluded from taxable income if the debts are forgiven as part of a bankruptcy proceeding.

To qualify for the tax-free treatment, the taxpayer will need to have filed for bankruptcy and the debts canceled at the order of the bankruptcy court.

For taxpayers faced with foreclosure or short-sales, it might be more advantageous to utilize the mortgage exclusion for acquisition debt and the insolvency exclusion for home equity and other types of canceled debt before considering a bankruptcy case.

Filing for bankruptcy can generate several tax implications, so for more details see the Bankruptcy Tax Guide (Publication 908) on the IRS Web site.

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