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In tough economic times, real estate owners and investors often
\nwork with their lenders to restructure mortgage debt. Lenders may
\nbe willing to reduce the interest rate, extend the repayment term
\nor even forgive a portion of the debt. These modifications can
\nprovide welcome financial relief, but it is important to understand
\nthe tax implications. Any time a lender reduces your principal
\nbalance, lowers your interest payments or gives you more time to
\npay, you may have cancellation of debt (COD) income, which is
\nreportable as ordinary income on your tax return.<\/p>\n
Not every modification of a mortgage loan triggers COD income,
\nhowever. There are a number of exceptions and exclusions that may
\nallow you to avoid or defer COD income. For purposes of this
\ndiscussion, several exclusions may be relevant:<\/p>\n
-
<\/p>\n
- Debts discharged in bankruptcy;<\/li>\n
\n <\/p>\n - Debts canceled when the taxpayer is insolvent. COD income is
\nexcluded only to the extent of your insolvency \u2014 that is, the
\namount by which your liabilities exceed the fair market value of
\nyour assets (Note: For partnerships, COD income is passed through
\nto the individual partners, so whether the insolvency exclusion
\napplies depends on each partner’s financial situation);<\/li>\n
\n <\/p>\n - Cancellation of qualified real property business indebtedness
\n(see below); and<\/li>\n
\n <\/p>\n - Cancellation of qualified principal residence indebtedness (see
\nbelow).<\/li>\n\n<\/ul>\n
QUALIFIED REAL PROPERTY BUSINESS INDEBTEDNESS<\/h3>\n
You may elect to exclude COD income (subject to certain limits)
\nfor debt that is incurred or assumed in connection with, and
\nsecured by, real estate used in a trade or business. In addition,
\ndebt incurred or assumed after 1992 must be used to acquire,
\nconstruct, or substantially improve the property. Real estate used
\nin a trade or business generally includes rental real estate, but
\nnot real estate held for sale (Note: For some real estate \u2014
\nsuch as properties subject to a triple-net-lease \u2014 it may be
\ndifficult to ascertain whether they are used in a trade or business
\nor are ineligible investment properties.) A separate exclusion is
\navailable for qualified farm indebtedness.<\/p>\nQUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS<\/h3>\n
Through the end of 2025, homeowners may exclude up to $750,000
\nin COD income ($375,000 for married couples filing separately) in
\nconnection with a mortgage used to buy, build or substantially
\nimprove their principal residence. The debt must be secured by the
\nresidence. This exclusion also applies to debt used to refinance
\nsuch a mortgage, up to the amount of the original mortgage
\nprincipal immediately before the refinancing.<\/p>\nREQUIREMENT TO REDUCE TAX ATTRIBUTES<\/h3>\n
Generally, the exclusions discussed above allow you to defer the
\ntax rather than avoid it permanently. When you exclude COD income,
\nyou are required to reduce certain tax attributes (but not below
\nzero), potentially increasing your tax liability in future years.
\nFor example, if you exclude COD income related to qualified real
\nproperty business indebtedness, you must reduce the tax basis of
\ndepreciable property by the amount excluded. Similarly, if you
\nexclude COD income related to qualified principal residence
\nindebtedness, and you continue to live in the home, you must reduce
\nits basis. If you take advantage of the bankruptcy or insolvency
\nexclusions, you’ll need to reduce one or more tax attributes,
\nsuch as net operating losses, certain tax credits, capital loss
\ncarryovers, or the basis of certain properties.<\/p>\nThe rules regarding application of the various exclusions and
\nreduction of tax attributes are quite complex, particularly for
\nreal estate owned by partnerships. If you have restructured
\nmortgage debt or plan to in the near future, please contact us to
\ndiscuss your tax-planning options.<\/p>\nThe content of this article is intended to provide a general
\nguide to the subject matter. Specialist advice should be sought
\nabout your specific circumstances.<\/em><\/p>\n<\/div>\n<\/div>\n\nPOPULAR ARTICLES ON: Real Estate and Construction from United States<\/p>\n