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Bankruptcy and Insolvency: Canceled Debt and Property Loss (2025 IRS Guide)

This guide covers “Bankruptcy and Insolvency” within canceled debt and property loss. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 4681 (2025), Canceled Debts, Foreclosures, Repossessions, and Abandonments, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

If you exclude canceled debt from income, you must reduce certain tax attributes (but not below zero) by the amount excluded. Use Part II of Form 982 to reduce your tax attributes. The order in which the tax attributes are reduced depends on the reason the canceled debt was excluded from income. If the total amount of canceled debt excluded from income (line 2 of Form 982) was more than your total tax attributes, the total reduction of tax attributes in Part II of Form 982 will be less than the amount on
line 2.

Bankruptcy and Insolvency

No tax attributes other than basis of personal-use property.

If the canceled debt you are excluding isn’t excluded as qualified principal residence indebtedness and you have no tax attributes other than the adjusted basis of personal-use property (see the list of seven tax attributes, later), you must reduce the basis of the personal-use property you held at the beginning of 2026 (in proportion to adjusted basis). Personal-use property is any property that isn’t used in your trade or business or held for investment (such as your home, home furnishings, and car). Include on line 10a of Form 982 the smallest of:

  1. The basis of your personal-use property held at the beginning of 2026,

  2. The amount of canceled nonbusiness debt (other than qualified principal residence indebtedness) that you are excluding from income on line 2 of Form 982, or

  3. The excess of the total basis of the property and the amount of money you held immediately after the cancellation over your total liabilities immediately after the cancellation.

For more information about the basis of property, see Pub. 551.

Example.

In 2024, you bought a car for personal use. The cost of the car was $12,000. You put down $2,000 and took out a loan of $10,000 to buy the car. The loan was a recourse loan, meaning that you were personally liable for the full amount of the debt.

On December 7, 2025, when the balance of the loan was $8,500, the lender repossessed and sold the car because you stopped making payments on the loan. The FMV of the car was $7,000 at the time the lender repossessed and sold it. The lender applied the $7,000 it received on the sale of the car against your loan and forgave the remaining loan balance of $1,500 ($8,500 outstanding balance immediately before the repossession minus the $7,000 FMV of the car).

Your only other assets at the time of the cancellation are the furniture in your apartment, which has a basis of $5,000 and an FMV of $3,000; jewelry with a basis of $500 and an FMV of $1,000; and a $600 balance in a savings account. Thus, the FMV of your total assets immediately before the cancellation was $11,600 ($7,000 car plus $3,000 furniture plus $1,000 jewelry plus $600 savings). You also had an outstanding student loan balance of $6,000 immediately before the cancellation, bringing the total liabilities at that time to $14,500 ($8,500 balance on car loan plus $6,000 student loan balance). Other than the car, which was repossessed, you held all of these assets at the beginning of 2026. The FMV and basis of the assets remained the same at the beginning of 2026.

You received a 2025 Form 1099-C showing $1,500 in box 2 (amount of debt that was canceled) and $7,000 in box 7 (FMV of the property). You can exclude all $1,500 of canceled debt from income because at the time of the cancellation, you were insolvent to the extent of $2,900 ($14,500 of total liabilities immediately before the cancellation minus $11,600 FMV of total assets at that time).

You check box 1b on Form 982 and enter $1,500 on line 2. You enter $100 on line 10a, the smallest of:

  1. The $5,500 basis of your personal-use property held at the beginning of 2026 ($5,000 furniture plus $500 jewelry),

  2. The $1,500 nonbusiness debt you are excluding from income on line 2 of Form 982, or

  3. The $100 excess of the total basis of the property and the amount of money you held immediately after the cancellation over the total liabilities at that time ($5,500 basis of property held immediately after the cancellation plus $600 savings minus $6,000 student loan).

You must reduce (by one dollar for each dollar of excluded canceled debt) the basis in each item of property held at the beginning of 2026 in proportion to the total adjusted basis in all the property. The total reduction, however, can’t be more than (3) above—the $100 excess of the total adjusted basis and the money held after the cancellation over the total liabilities after the cancellation. See the basis attribute under All other tax attributes next.

Thus, you reduce the basis as follows.

  1. The furniture’s basis is 91% of the total adjusted basis ($5,000 divided by $5,500), so you reduce it by $91 (the $100 excess in (3) multiplied by 0.91).

  2. The jewelry’s basis is 9% of the total adjusted basis ($500 divided by $5,500), so you reduce it by $9 (the $100 excess in (3) multiplied by 0.09).

All other tax attributes.

If the canceled debt is excluded by reason of the bankruptcy or insolvency exclusion, you must use the excluded debt to reduce the following tax attributes (but not below zero) in the order listed unless you elect to reduce the basis of depreciable property first, as explained later. Reduce your tax attributes after you figure your income tax liability for 2025.

  1. Net operating loss (NOL). First reduce any 2025 NOL and then reduce any NOL carryover to 2025 (after taking into account any amount used to reduce 2025 taxable income) in the order of the tax years from which the carryovers arose, starting with the earliest year. Reduce the NOL or carryover by one dollar for each dollar of excluded canceled debt.

  2. General business credit carryover. Reduce the credit carryover to or from 2025. Reduce the credit carryovers to 2025 in the order in which they are taken into account for 2025. For more information on the credit ordering rules for 2025, see the Instructions for Form 3800. Reduce the carryover by 331/3 cents for each dollar of excluded canceled debt.

  3. Minimum tax credit. Reduce the minimum tax credit available at the beginning of 2026. Reduce the credit by 331/3 cents for each dollar of excluded canceled debt.

  4. Net capital loss and capital loss carryovers. First reduce any 2025 net capital loss and then any capital loss carryover to 2025 (after taking into account any amount used to reduce 2025 taxable income) in the order of the tax years from which the carryovers arose, starting with the earliest year. Reduce the net capital loss or carryover by one dollar for each dollar of excluded canceled debt.

  5. Basis. Reduce the basis of the property you hold at the beginning of 2026 in the following order (and, within each category, in proportion to adjusted basis).

    1. Real property used in your trade or business or held for investment (other than real property held for sale to customers in the ordinary course of business) if it secured the canceled debt.

    2. Personal property used in your trade or business or held for investment (other than inventory and accounts and notes receivable) if it secured the canceled debt.

    3. Any other property used in your trade or business or held for investment (other than inventory, accounts receivable, notes receivable, and real property held for sale to customers in the ordinary course of business).

    4. Inventory, accounts receivable, notes receivable, and real property held primarily for sale to customers in the ordinary course of business.

    5. Personal-use property (property not used in your trade or business nor held for investment).

    Reduce the basis by one dollar for each dollar of excluded canceled debt. However, the reduction can’t be more than the excess of the total basis of the property and the amount of money you held immediately after the debt cancellation over your total liabilities immediately after the cancellation.

    For allocation rules that apply to basis reductions for multiple canceled debts, see Regulations section 1.1017-1(b)(2). Also see Election to reduce the basis of depreciable property before reducing other tax attributes, later.

  6. Passive activity loss and credit carryovers. Reduce the passive activity loss and credit carryovers from 2025. Reduce the loss carryover by one dollar for each dollar of excluded canceled debt. Reduce the credit carryover by 331/3 cents for each dollar of excluded canceled debt.

  7. Foreign tax credit. Reduce the credit carryover to or from 2025. Reduce the credit carryovers to 2025 in the order in which they are taken into account for 2025. Reduce the carryover by 331/3 cents for each dollar of excluded canceled debt.

Election to reduce the basis of depreciable property before reducing other tax attributes.

You can elect to reduce the basis of depreciable property you held at the beginning of 2026 before reducing other tax attributes. You can reduce the basis of this property by all or part of the canceled debt. Basis of property is reduced in the following order.

  1. Depreciable real property used in your trade or business or held for investment that secured the canceled debt.

  2. Depreciable personal property used in your trade or business or held for investment that secured the canceled debt.

  3. Other depreciable property used in your trade or business or held for investment.

  4. Real property held primarily for sale to customers if you elect to treat it as if it were depreciable property on Form 982.

Basis reduction is limited to the total adjusted basis of all your depreciable property. Depreciable property for this purpose means any property subject to depreciation or amortization, but only if a reduction of basis will reduce the depreciation or amortization otherwise allowable for the period immediately following the basis reduction. If the amount of canceled debt excluded from income is more than the total basis in depreciable property, you must use the excess to reduce the other tax attributes in the order described earlier under All other tax attributes. In figuring the limit on the basis reduction in (5), Basis, use the remaining adjusted basis of your properties after making this election. See Form 982 for information on how to make this election. The election can be revoked only with IRS consent.

Recapture of basis reductions.

If you reduce the basis of property under these provisions and later sell or otherwise dispose of the property at a gain, the part of the gain due to this basis reduction is taxable as ordinary income under the depreciation recapture provisions. Treat any property that isn’t section 1245 or section 1250 property as section 1245 property. For section 1250 property, determine the depreciation adjustments that would have resulted under the straight line method as if there were no basis reduction for debt cancellation. See Pub. 544, or Pub. 225, for more details on sections 1245 and 1250 property and the recapture of gain as ordinary income.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.

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