Chapter 7 Bankruptcy is a bankruptcy where you do not make payments back to your creditors. Instead, your liability on the debt id “discharged” in bankruptcy. Once discharged in bankruptcy, you are no longer liable on the debt, tax free, forever. So while the creditor will write off the debt as a loss on their tax returns, the debt forgiven is not taxable to you under the IRS Code. The IRS Code basically says whatever debt is forgiven as a result of a Title 11 Bankruptcy, which Chapter 7 Bankruptcy is, is not taxable to you. The tax form you should file with your tax return is IRS Form 983.
Now, in a Chapter 7 Bankruptcy the focus is on your assets. Most people who file Chapter 7 Bankruptcy lose no assets to the trustee. For most people who file Chapter 7 Bankruptcy, their assets are what we refer to as “exempt”. When your assets are “exempt” they cannot be used to settle your debts.
For the few people who do file and have non-exempt or unprotected assets, in most cases the value of their non-exempt assets is 10k or less. For example, suppose you owe 100k in credit card debt. If I proposed to you that I could take your 10k in nonexempt assets in full settlement of your 100k in debt, tax free, would you do it? Of course you would! That is an exceptional deal! You give up 10k in assets to lose your liability on 100k in debt, tax free. Sometimes people get hung up on losing something to miss what they are gaining in the end.
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