Successfully negotiating a debt settlement may feel like you've hit the jackpot. But before you start celebrating, make sure you understand the true cost of having that debt cancelled.
Dumping debt
First, it's important to understand what happens when a debt is cancelled. For instance, you can have debt forgiven through a debt settlement with a credit card agency or even have mortgage debt wiped out. Getting debt cancelled doesn't happen overnight, and you'll have to prove to a creditor that you are in desperate financial shape to get a deal. But once a debt is cancelled, you no longer have any obligation to make payments on it.
Getting a deal
Generally, you must already be behind on your debt payments and be able to document why you are experiencing a financial hardship. It may take several attempts to contact your creditor to reach the right person to cut a deal with. Once you have a deal in progress, be sure to comply with all requests for information as quickly as possible.
Strings are attached
So what's the catch? Well, depending upon your situation you could end up owing taxes on the amount of forgiven debt. That means that if your creditor agrees to forgive debt of $10,000, you may still end up owing taxes on it depending upon your income. However, there are some instances where forgiven mortgage debt may not be taxable, such as:
- Qualified principal residence indebtedness
- If debts were discharged through bankruptcy
- If you have certain farm-related debts
- If you have a non-recourse loan and the only thing the lender can do is repossess the property
Having debt from credit cards or a mortgage forgiven can give you some breathing room to get your finances back on track. But make sure you fully understand what is involved and how forgiven debt can impact your tax return. Internal Revenue Service Publication 4681 can give you more information about cancelled debts.
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