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IRS Expands Cancellation of Indebtedness Income Exclusion

February 13, 2014 Business & Tax Blog Cancellation of Indebtedness Income

When a lender discharges debt for less than full consideration, the borrower by default recognizes income for federal income tax purposes. “Qualifying Real Property Indebtedness” is an exception. Forgiveness of Qualifying Real Property Indebtedness may be excluded from income. New IRS guidance expands this exclusion.

The Qualifying Real Property Indebtedness exclusion generally applies to debt secured by real property, if a taxpayer incurred the debt in connection with a business using the property. The IRS guidance clarifies that “secured” debt is not limited to a traditional real estate mortgage. A debt secured by the membership interest in a “disregarded entity” limited liability company that owns real estate may qualify, even though the lien does not attach directly to the real estate.

IRS targeted the guidance at a specific mezzanine loan structure, but taxpayers in other structures may utilize the exclusion as well. Other notable cancellation of indebtedness income exclusion opportunities include: taxpayer insolvency, debt forgiven in certain bankruptcy proceedings, and seller-financed debt forgiven as a purchase price adjustment.

Here is a link to the IRS guidance:

E. John Wagner, II