In the case of Weiderman v. Commissioner, T.C. Memo. 2020-109,[1] the taxpayer found that simply using a loan to purchase a residence isn’t sufficient to make it into qualified principal residence indebtedness. The taxpayer was looking to claim an exclusion from cancellation of indebtedness income under IRC §108(a)(1)(E).

In the case of Hamilton v. Commissioner, TC Memo 2018-62, the taxpayer had excluded from income cancellation of indebtedness of $158,511.  The taxpayers claimed they qualified for the insolvency exclusion under IRC §108(a)(1)(B), with liabilities in excess of assets at the time of the discharge of $165,871.  But the IRS objected that they had omitted from their calculation of insolvency a significant asset—a savings account held by their son that had been funded by the taxpayers and which the taxpayers regularly used to pay personal expenses.

Under IRC §61(a)(12), a discharge of indebtedness is specifically called out as a type of gross income subject to tax.  However, IRC §108 provides that, in a number of specific circumstances, a taxpayer is able to exclude from income some or all of the discharge.

Image copyright flynt / 123RF Stock Photo

In the case of Simonsen v. Commissioner, 150 TC No. 8, the Tax Court reaffirmed its previously stated position regarding a short sale when a nonrecourse debt is involved.  As well, for the first time the Court also addressed the reportable gain/loss on a property converted to rental use that was sold for less than its original cost but more than its date of conversion fair market value.

The couple in question had purchased a townhouse in San Jose in 2005 for $695,000.  They lived in that home for five years, during which the real estate crisis hit.  In 2010 they relocated to Southern California and began renting the townhouse.  At the time it was converted to a rental the fair value had declined to $495,000.

Image copyright damedeeso / 123RF Stock Photo

In News Release IR-2018-33 the IRS announced that it was now able to begin accepting returns claiming certain tax benefits retroactively restored for 2017 by the Bipartisan Budget Act of 2018.  The three benefits that the IRS is now ready to accept returns containing are the following:

• Exclusion from gross income of discharge of qualified principal residence indebtedness (often, foreclosure-related debt forgiveness),
• Mortgage insurance premiums treated as qualified residence interest, and
• Deduction for qualified tuition and related expenses.

These provisions had expired at the end of 2016 and Congress had not enacted legislation to extend them for an additional year until the passage of the Bipartisan Budget Act on February 9.

Image copyright boarding1now / 123RF Stock Photo

The general rule is that income from the cancellation of debt is included in a taxpayer’s gross income. [IRC §61(a)(12)]  However, IRC §108 provides various exclusions from income for cancellation of debt if certain requirements are met.  One of those exclusions, found at IRC §108(a)(1)(B), provides for excluding from income cancellation of debt to the extent the taxpayer is insolvent at the time the debt is discharged.

The taxpayers in the case of Schieber v. Commissioner, TC Memo 2017-32 argued that they were insolvent at the time GMAC Mortgage had cancelled debt of $448,671.  The debt was secured by a piece of property (the Stockdale Highway property) that was not the taxpayer’s principal residence. 

Image copyright serezniy / 123RF Stock Photo

The special rule for exclusion from income of cancellation of debt income related to the discharge of certain home mortgage debt (IRC §108(a)(1)(E)) was only extended by Congress through December 31, 2016 in the PATH Act.  However, Congress did provide that the relief would apply to discharges after that date if certain events took place before December 31, 2016 that had the effect of entering into an agreement to cancel the debt at some later date.

In Notice 2016-72 the IRS provides guidance about how that “special rule” would apply to the Federal Housing Finance Agency’s (FHFA’s) principal reduction modification program (PRMP) and the Home Affordable Modification Program (HAMP).

Image copyright mrgao / 123RF Stock Photo

In the case of Newman v. Commissioner, TC Memo 2016-125 the Tax Court looked at two questions—did Mr. Newman have cancellation of debt income in 2011 from an overdraft on a bank account he never paid back and, if so, was he insolvent at the time the debt was discharged.

The IRS finalized regulations (TD 9771) that were issued in proposed form back in 2011(Proposed Reg. §1.108-9, REG-154159-09,  4/13/11) regarding cancellation of debt relief provisions for bankruptcy and insolvency found in IRC §108 as they relate to grantor trusts and disregarded entities (generally single member LLCs).

The IRS had indicated when the proposed regulations were issued that some taxpayers had attempted to interpret the provisions granting relief to taxpayers who had a discharge of indebtedness involving insolvency or bankruptcy as applying at the disregarded entity level rather than at the level of the taxpayer treated as the owner of the disregarded entity.

The issue of what items IRS can and cannot change that arose in “closed” years is the issue discussed in Chief Counsel Advice 201604017.  In this memorandum the question arose regarding whether the IRS can make adjustments to the amounts included in income under the special temporary provision that allowed for deferral of cancellation of indebtedness income under IRC §108(i).

In Action on Decision 2015-01 the IRS announced that it will not follow the Tax Court’s decision in four cases that were decided on the same day in 2004 that involved the interaction of the bankruptcy code and taxation of partners on cancellation of debt income.