Sally and Ed Each Own Property with a Fair Market

Essay

Sally and Ed each own property with a fair market value less than the amount of the outstanding mortgage on the property and also less than the original cost basis. They each were able to convince the mortgage holder to reduce the principal amount on the mortgage. Sally's mortgage is on her personal residence and Ed's mortgage is on rental property he owns. Both debts are recourse.
a.Each taxpayer's liabilities were reduced. Therefore, their net worth has increased as measured using the cost basis in the assets. Each taxpayer also experienced a loss in the value of their assets. However, the losses were not realized (because each taxpayer still owns the property). Thus, each taxpayer had income from the reduction in debt, but no recognized loss. Fortunately, recent legislation permits in effect through 2017, the taxpayer whose property is a personal residence to exclude the income from debt discharge from gross income. The taxpayer who owns the rental home is not eligible for this debt discharge exclusion.
b. Allowing the exclusion from income for the homeowner but not for the investor can only be justified on the basis of a value system that says we should modify the otherwise equitable rules to favor home ownership.