Question

Robin Corporation had assets with a FMVof $600,000 and liabilities of $810,000. By agreement of its creditors, the liabilities were reduced to $510,000. What amount of income must Robin report in the current year as a result of the cancellation of indebtedness?

Answer 1

$300,000

Step-by-step explanation:

The IRS considers that cancelled, forgiven, reduced or discharged debts must be included as normal income, and that the individual or company must pay normal income taxed on that income.

The logic behind this is that the discharged part of the debt will be reported as loss by the creditors, and since the IRS doesn't like to lose money, someone else must recognize that loss as a gain. In this case, since Robin's creditors report a $300,000 loss, Robin must report $300,000 as income.

This was true even for foreclosures that were executed for a lower amount. The debtor that lost his/her house had to pay taxes for the remaining part of the debt. That is why the Mortgage Forgiveness Debt Relief Act was passed in 2007. So if you lose your house, you do not have to pay taxes on the part of the debt that was not covered by the foreclosure.