| Chapter: | Reading | Topic |
A taxpayer borrowed $45,000 secured by land with a basis of $20,000. The taxpayer could not pay the principal, so the bank foreclosed and sold the land for $35,000 as full settlement of the debt. What income should the taxpayer recognize?
Unless excluded by law, cancelled (ie, forgiven) debt is subject to income tax. Recognized income is determined similarly to that from a sale, which equals the value of the benefit received (ie, cancelled debt) minus the adjusted basis of any secured property that was taken (eg, repossessed) from the taxpayer to settle the debt.
| Recognized income = forgiven debt − adjusted basis |
| = $45,000 − $20,000 |
| = $25,000 |
(Choice A) Income of $10,000 results from reducing cancelled debt by the land's selling price ($35,000) instead of its basis ($20,000). This omits income from the land's appreciation.
(Choice B) Income of $15,000 results from reducing the land's selling price ($35,000) instead of the entire benefit received ($45,000), therefore reflecting only the land's appreciation ($35,000 − $20,000). The amount cancelled in excess of appreciation is omitted.
(Choice D) Income of $35,000 represents the land's selling price only, not the net effect of value received against basis given up.
Things to remember:
Unless excluded by law, cancelled (forgiven) debt is subject to income tax. The taxpayer's recognized income equals the cancelled debt reduced by the adjusted basis of property repossessed to settle the debt.
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