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Tax help for rental debt cancellation


Investors who have multiple rental properties and experience a debt cancellation relating to a rental property might be missing an important tax break.

The IRS has ruled that cancellation of debt income attributable to passive activity expenditures, such as the purchase of a rental property, is passive activity income. The IRS says in Publication 4681 to report the income as rental income on Schedule E. Reporting the income as passive may permit a taxpayer to have an offsetting tax deduction for a passive activity loss for another property.

CAncellation of debt income attributable to funds used for a personal purpose, such as cash received from refinancing a property used to pay for a personal car or vacation, is not passive activity income and must be reported as other income.

“Many tax return preparers and individuals who use tax return software to prepare their own income tax returns report cancellation of debt income from rental properties as ’other income’,” says Michael Gray, CPA. “They miss claiming allowable deductions to reduce what otherwise may be a big tax bill.”



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