Tax Attribute

Tax Attribute Definition: An Overview with Examples

Key Takeaways

Tax attributes are losses or credits reduced when debt cancellation is excluded from income under specific IRS rules.
Cancelled debt in bankruptcy or insolvency often doesn’t increase taxable income, but reduces certain tax benefits.
Section 108 of the IRC allows exclusion of cancelled debt from gross income if insolvency or bankruptcy applies.
Taxpayers may use IRS Form 982 to reduce the basis of depreciable assets when adjusting for discharged debt.
The order of tax attributes reduced includes: net operating loss, capital loss, and cost basis, among others.
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What Is a Tax Attribute?

Tax attributes are adjustments in a taxpayer’s financial records, often made when an individual is insolvent or going through bankruptcy. These adjustments involve reducing specific tax benefits or economic advantages like tax credits and the adjusted basis of property. This reduction is necessary because the IRS excludes canceled debt from an individual's gross income. Understanding tax attributes helps you navigate the complex interactions between insolvency, bankruptcy, debt cancellation, and tax obligations. Armed with this knowledge, you can better plan for potential financial situations and their tax implications.

Understanding How Tax Attributes Operate

According to the cancelation of debt (COD) income rules, canceled debt will not be taxable if:

The debt was discharged in bankruptcy.

The debtor is insolvent, with debts greater than assets, but only to the extent of the insolvency.

The canceled debt was a gift or an inheritance from a friend or relative.1

Individual and business taxpayers who are forgiven their debts due to insolvency or bankruptcy do not have to include the forgiven debt as part of their taxable gross income. However, the discharged debt translates to financial gain. Under ordinary taxation principles, the Internal Revenue Service (IRS) taxes most financial gains earned by individuals and businesses. In this case, Section 108 of the Internal Revenue Code (IRC) exempts gains from forgiven debt from being factored into taxable income, providing a measure of relief for certain taxpayers who find themselves facing serious financial difficulties.2

However, the amount excluded from gross income is used to reduce certain tax attributes. Excluding income under Section 108 requires that a taxpayer postpone his or her tax liability by decreasing dollar-for-dollar (or, in some cases, 1/3 of each dollar) certain tax attributes that would otherwise be available to offset future income.3 So, in effect, when a debt is canceled, the taxpayer forfeits some tax attribute benefits in exchange for receiving favorable treatment relating to the bankruptcy.

The Internal Revenue Code (IRC) stipulates that taxpayers must reduce seven tax attributes in the following order:

Net operating loss from any business

General business credit carryover

Alternative minimum tax credit

Capital loss

The cost basis of property

Passive activity loss

Foreign tax credit carryover3

Taxpayers may use IRS Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness to reduce the basis of depreciable assets before reducing the other tax attributes.4

Tax Attribute Example Explained

For example, if $5,000 in debt was forgiven, then the taxpayer could elect to have the basis (cost price) of their rental property reduced by $5,000 and defer the tax until the property is sold. Reducing the cost basis of an asset means that a taxpayer will recognize a higher taxable gain (or smaller loss) from the sale of the asset. If the property is sold for a gain, then $5,000 of that gain will be taxed as ordinary income.

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Internal Revenue Service. "Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) (2018)," Pages 4-9. Accessed Jan. 15, 2020.

GovInfo. "26 U.S.C. 108 - Income from discharge of indebtedness," Pages 454-455. Accessed Jan. 18, 2020.

Internal Revenue Service. "Publication 908 (02/2019), Bankruptcy Tax Guide." Accessed Jan. 14, 2020.

Internal Revenue Service. "Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)." Accessed Jan. 15, 2020.

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