FSA Debt Write-off -- Turned over to IRS -- HELP!!!

My parents bought a farm through First Savings and Loan and FmHA (FSA) in 1980. Over the years they were done wrong again and again by FmHA. Finally, in 1986, FSA foreclosed without them being behind on payments and the farm was sold. Without my parents knowledge, a lien had been placed on their home and land they owned prior to purchasing the farm. We fought them off for 13 years. They sold their home and land at the courthouse doors in September 2000. Because the statute of limitations had passed, FSA could not collect the debt which went from $90,000 original debt to over $300,000 with interest. We just received tax papers showing that they turned this in to the IRS as a gift of over $300,000 in debt write-off and are claiming this as income. My dad is 59 years old and makes less than $10,000 a year. My mom is in a nursing home and covered by Medicaid which requires that he stay within certain a income range. He was planning to retire. He lives with my husband and I and doesn't own anything except his 1989 Ford Truck and carpenter tools he uses to make a living and the clothes on his back. He lost everything when they took his home. There is no way he can pay taxes on $300,000 plus dollars and I don't think he should have to. What can he do? Does he need to file bankrupt?

The general rule is that a taxpayer, such as your father, must show as taxable income the amount of any cancelled debt s/he owed. However, there are two exceptions, which I believe apply to your father so that there will be no income from this: (1) The debt was canceled when he was insolvent, and (2) the debt was qualified farm debt.

Insolvency. You are insolvent to the extent your liabilities are more than the fair market value of your assets immediately before the cancellation of debt. Taxpayers can exclude canceled debt from gross income up to the amount by which they are insolvent. If the canceled debt is more than this amount and the debt qualifies, they can apply the rules for qualified farm debt or qualified real property business debt to the difference. Otherwise, they include the difference in gross income.

Qualified Farm Debt Taxpayers can exclude from income a canceled debt that is qualified farm debt owed to a qualified person. if the taxpayer was insolvent when the debt was cancelled, this exclusion applies only to the extent the canceled debt is more than the amount by which the taxpayer was insolvent.

A debt is qualified farm debt if both the following requirements are met.
• The taxpayer incurred it directly in operating a farming business.
• At least 50% of your total gross receipts for the 3 tax years preceding the year of debt cancellation were from the taxpayer’s farming business.

Qualified person. This is a person who is actively and regularly engaged in the business of lending money. A qualified person includes any federal, state, or local government, or any of their agencies or subdivisions.


These rules are from the discussion of “Cancellation of Debt” in IRS Publication 225, Farmer’s Tax Guide, Chapter 4. You can download the publication at the IRS site at: [url]http://www.irs.ustreas.gov/forms_pubs/index.html[/url]