If your lender forecloses on your home or you sell it as a short sale (meaning you sell it for less than you owe the lender), the lender may forgive the unpaid balance on your mortgage. While forgiveness of unpaid debt may sound like a good thing, it may not at tax time.

You may receive a 1099C from the Internal Revenue Service. As a result, you could owe thousands of dollars in taxes on the forgiven debt.

What is a 1099C?

A 1099C is a form that reports cancelled debts. A 1099C also lets the Internal Revenue Service know that you’ve received an income from a different source than your usual income. Yes, your forgiven debt is counted as income.

When a debt is cancelled, it then becomes ordinary income in the eyes of the United States tax laws. Any 1099C-reported income over $600 has to go on your tax form. That means you have to pay taxes on your forgiven debts.

When you file your tax return, you need to include the 1099C income on your taxes as normal monthly income. Depending on your situation, you could end up owing taxes or receiving a smaller return that you were expecting because of the new higher income you’re reporting.

Fortunately, there are ways to avoid the tax implications of canceled debt. Filing bankruptcy will discharge debts, including the forgiven debt on your mortgage. With the right information, you may be able to get rid of mortgage debt without creating a tax burden.