What it's all about - Concepts of Accretion of Wealth
When money is borrowed, the borrower receives an asset but contemporaneously incurs an obligation to repay the borrowed money. Although there is an increase in assets there is a corresponding increase in debt and thus there is no accretion or net increase in wealth. It is for this reason that we don’t have to pay taxes upon receipt of borrowed money.
When, however, the obligation of repayment is cancelled or discharged, such cancellation or discharge can result in an accretion or net increase in wealth giving rise to taxable income.
The acronym DOI is sometimes used to describe “Discharge of Indebtedness” Income as is COD “Cancellation of Debt” Income. Both make reference to the same thing.
At Schuh & Goldberg, LLP we frequently encounter the issue. Navigating through these issues requires special knowledge of both taxation and debt relief law. Don't call after you've made your deal with a lender ... it might be too late.
We are familiar with all of the ways that can help you avoid or defer the taxation of COD Income. The most important exceptions are:
The Bankruptcy Exception - §108(a)(1)(A)
The Insolvency Exception - §108(a)(1)(B) - this one can be tricky because when "insolvency" is calculated exempt assets like retirement account are included
The Disputed Liability Exception - This is a case law exception recognized in Zarin v. Commissioner, 916 F.2d 110 (3d Cir. 1990)The “disputed debt” doctrine holds that if the debt "forgiven" was the subject of a bona fide disputed, there is no COD income because it was never really owed in the 1st place, it was a bona fide, disputed debt.
The Exception for Qualified Real Property Business Indebtedness (QRPBI) - §108(a)(1)(D) -QRPBI is defined at §108(c)(3). There also are deferral techniques under §108(i) for “business debt” (i.e. not necessarily secured by real property).
The Exception for Qualified Principal Residence Indebtedness - §108(a)(1)(E) - Enacted in 2007, amended in 2008 and possibly expiring effective January 1, 2013 as part of the fiscal cliff problems.
Many practitioners are unaware that in some cases a guarantor's release of liability for the debt of another, e.g. a principal's guaranty of a corporate liability, does not result in COD Income. This is fully consistent with the concept of accretion in wealth. The guarantor did not receive the borrowed funds. The entity whose debt the guarantor guaranteed was the one that received the borrowed funds. The Treasury Regulation that governs the issuance of 1099-C, § 1.6050P-1(d)(7), provides that:
“(7) Guarantors and sureties. Solely for purposes of reporting requirements of this section, a guarantor is not a debtor. Thus, in the case of a guaranteed indebtedness, reporting under this section is not required with respect to a guarantor, whether or not there has been a default and demand for payment made upon the guarantor.”
At Schuh & Goldberg, LLP we understand the issues. We know where the traps have been laid.
Call us to discuss your unique situation. We can help where others can't!