According to the IRS, "Cancellation of Debt income is not always taxable." The most common situations when cancellation of debt income is not taxable involve the following situations as shown below.

1.Qualified principal residence indebtedness:
This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.

2.Bankruptcy:
Debts discharged through bankruptcy are not considered taxable income.

3.Insolvency:
If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.

4.Certain farm debts:
If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.

5.Non-recourse loans:
A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences."

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Ask TaxGuru Please refer to the legal disclaimer.

When you obtained the money you were not required to include the loan continues in income because you had an responsibility to pay back the lending company. When that responsibility is consequently pardoned, the amount you received as loan continues is reportable as income because you no longer have an responsibility to pay back the lending company.

Debt cancellation isn't always a taxable event. The Mortgage Forgiveness Debt Relief Act of 2007, which excludes certain types of mortgage debt from taxes, got spared in the final hours of the so-called fiscal-cliff negotiations and was extended.