If you have a debt canceled, you'll probably need to include the canceled amount in your taxable income unless you qualify for an exception. One common exception is to claim insolvency -- that is, the amount of your debts were greater than the value of your assets before the cancellation took place. However, what assets to include and how to value them are not well understood by many individuals. Here's what you need to know about estimating your asset values for claiming insolvency.
Make a list of your assets
First, make a list of the total assets you owned immediately before the debt was canceled. IRS Publication 4681 (link opens PDF) includes an insolvency worksheet on page 8, which lists the assets you need to value. These include:
- Bank account balances (include cash)
- Real property
- Cars and other vehicles
- Household goods and furnishings, such as appliances, electronics, and furniture
- Stocks and bonds
- Investments in collectibles (coins, stamps, etc.)
- Firearms, sports, photographic, or any other hobby equipment
- Retirement accounts
- Interest in pension plan(s)
- Interest in education accounts
- Cash value of life insurance
- Security deposits with landlords, utilities, etc.
- Interests in partnerships
- Value of investment in a business
- Other investments
- Other assets -- anything you own that has significant resale value should be included
Valuing your assets
Once you've made the list, you'll need to put down the value of each asset immediately before the debt was canceled. Some of these are easy to do. For example, if you log on to your bank accounts, you should be able to determine their balance the day before your debt was forgiven.
Others are more difficult, as the IRS wants you to list each asset's "fair market value." You can estimate the value of real estate through websites like Zillow or simply by asking a local real estate professional for a written price opinion. You can look up your car's value on websites like Kelley Blue Book. For other items, you can use websites like eBay to see what comparable items are selling for. And property such as furniture and clothing can be valued with thrift-shop valuations -- here's a guide (link opens PDF) by Goodwill you can use.
If you fill out the insolvency worksheet with the amounts of your pre-cancellation debts and the value of your assets, you arrive at a positive number on the last line, you're considered insolvent for IRS purposes. In order to exclude the canceled debt from your taxable income, you'll need to fill out IRS Form 982 (link opens PDF) and check the box on line 1b -- "Discharge of indebtedness to the extent insolvent." Although it doesn't specifically say to attach the insolvency worksheet, it's not a bad idea to do so, as the IRS is known to request documentation in insolvency cases. It's also a good idea to keep the proof of set-in-stone asset values (those not subject to opinion), such as bank statements, retirement account statements, and any property appraisals you may have.
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