1. TAXATION OF CANCELLATION OF DEBT

2. Canceled Debt Generally speaking, if a debt for which you are personally is canceled or forgiven, other than by gift, you must include the canceled amount in income. Debt for which you are personally liable is recourse debt.

3. Canceled Debt If you do not have personal liability for the debt, you do not have ordinary income from cancellation of debt unless the lender agrees to discount the debt for early payment ( i.e. a short sale) or agrees to a loan modification that results in a the reduction of the principal balance of the debt.

4. Canceled Debt If the lender offers to reduce the principal balance of a loan if it is paid off early (i.e. a short sale), or agrees to a loan modification that reduces the principal balance of the loan, the amount of the principal reduction is canceled debt whether or not you are personally liable for the debt.

5. Rules on Sales or Dispositions NON-RECOURSE DEBT – Foreclosure The entire debt on property subject to non- recourse debt is treated as the amount realized on the disposition of the property. Any amount in excess of the FMV of the property does not result in ordinary income.

6. Rules on Sales or Dispositions RECOUSE DEBT: If the property was subject to recourse debt in excess of the FMV of the property, the amount of the debt in excess of the FMV may result in ordinary income from cancellation of debt. Taxable income has several components: –The gain or loss measured by the difference between the FMV of the property minus the adjusted basis of the property. –The ordinary income from the canceled debt over the FMV of the property.

7. Exclusions Insolvency Qualified Farm Indebtedness Qualified Principal Residence Indebtedness Qualified Real Property Indebtedness

8. Insolvency To the extent you were insolvent immediately before the cancellation of debt, you do not have cancellation of debt income. Insolvency is determined to the extent the total of all your liabilities exceeded the FMV of all of your assets immediately before the cancellation.

9. Qualified Principal Residence Debt You can exclude COD from income if it is qualified principal residence debt. Qualified principal residence debt is debt acquired to acquire, construct or substantially improve your principal residence. Maximum amount is $2,000,000 ($1,000,000 MFS)

10. Qualified Real Property Business Debt Incurred or assumed in connection with real property used in a trade or business. Secured by such real property. Incurred or assumed before 1993 or after 1992. Debt to which you elect to apply these rules. There are a number of limiting rules that apply to this exclusion that require a detailed analysis of the individual’s facts and circumstances.

11. Comprehensive Example John & Patricia purchased a new home in 2006 for $3,000,000. They put down $400,000 and took out a non-recourse loan in the amount of $2,600,000. By August, 2009, their property value had fallen to $1,750,000.

12. Non-Recourse Analysis If the original loan was non-recourse, and they turned the property over to the lender in December, 2009 either through foreclosure or deed in lieu, the tax consequence would be as follows:

13. Non-Recourse Analysis Sales Price$2,500,000 Cost Basis (3,000,000) Non Deductible Loss 500,000 The sales price is deemed to the CURRENT balance of the loan at the time of the foreclosure.

14. Recourse Analysis Gain or Loss on Sale: Foreclosure Sale$1,750,000 Cost Basis (3,000,000) Non deductible loss 1,250,000

15. Recourse Analysis Insolvency Analysis: Assets: Cash in bank$ 15,000 Retirement account 17,000 Auto 10,000 Total 42,000 Liabilities: Remaining balance on loan $750,000 Credit cards 18,000 Total 768,000 Amount of Insolvency $726,000

16. Recourse Analysis Qualified Principal Residence Debt Exclusion: Debt:$2,500,000 Max Exclusion (2,000,000) Amt not qualifying 500,000 Amount of Debt Forgiveness $750,000 Less Amt not qualifying (500,000) Amount eligible for exclusion 250,000

17. Recourse Analysis Taxpayer cannot both the Qualified Residence Debt Exclusion and the the Insolvency Exclusion for the amount of Qualified Residence Debt but can elect to the Insolvency Exclusion instead of the QRDE. In this example, John and Patricia do not elect the insolvency exclusion for the amount of the Qualified Residence Debt and they exclude $250,000 of that debt under that rule. Since $500,000 of the original debt was not eligible for the Qualified Residence Debt ($2,500,000 – 2,000,000= 500,000), John and Patricia can still apply the Insolvency Exclusion to the remaining $500,000 of Cancelled Debt Income. Cancelled Debt $ 750,000 Less QRDE (250,000) Remaining COD 500,000 Insolvency (726,000)