Definition
A tax rule allowing cancellation of debt income to be excluded from taxable income to the extent the debtor is insolvent (liabilities exceed assets), using Form 982 to claim the exclusion.
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The insolvency exclusion is a powerful tool for troubled borrowers. If your liabilities exceed your assets (you're insolvent), you can exclude COD income from taxation up to the amount of insolvency. If you're insolvent by $100,000 and have $50,000 in COD income, all $50,000 is excluded. If you have $150,000 COD income, only $100,000 is excluded (limited by insolvency amount). Insolvency is calculated by comparing total liabilities to total assets, including all property and debts. This requires detailed financial analysis but can save significant tax. The exclusion is claimed on Form 982, filed with your tax return. Understanding insolvency status is important for anyone facing debt forgiveness—it might eliminate tax impact. Divorce settlements, business debt cancellation, and foreclosure situations often trigger insolvency and allow COD exclusion. Tax professionals help calculate insolvency accurately to maximize available exclusion.
Pro Tip
If facing debt forgiveness, calculate your insolvency. You might exclude all COD income if insolvent, saving significant tax.
Example
A person with total liabilities of $500,000 and total assets of $300,000 is insolvent by $200,000. They have $100,000 COD income from mortgage forgiveness. All $100,000 is excluded via insolvency exclusion on Form 982.