Academic journal article Journal of Accountancy

Cancellation of Nonrecourse Debt

Academic journal article Journal of Accountancy

Cancellation of Nonrecourse Debt

Article excerpt

It's not uncommon for a taxpayer that has defaulted on a debt to find the property securing the debt is worth less than the amount of the liability. In the event of a sale, the tax treatment will differ depending on how the debt is structured. If the debt is "recourse," a sale of the property results in a gain equal to the difference between the value of the property and its basis. A taxpayer would have cancellation-of-debt (COD) income equal to the difference between the recourse debt and the value of the property. If the debt is "nonrecourse," the full amount of the debt is included in the sale proceeds, resulting in gain on the sale and no COD income. Since an insolvent taxpayer can exclude COD income, tax-payers frequently try to avoid sale treatment when disposing of property securing nonrecourse debt so they can report COD income.

A partnership, 2925 Briarpark, Ltd., borrowed approximately $25,600,000 in a nonrecourse loan secured by real property. Its basis in the property was approximately $11,100,000. The partnership was in default on the note. The creditor concluded it would get the largest recovery if the property was sold for its fair market value. The creditor agreed to allow Briarpark to sell the property and to cancel the note if Briarpark transferred the net sales proceeds to the creditor.

Briarpark round a purchaser willing to pay $11,600,000 for the property if all debts and liens were cancelled. The partnership sold the property and transferred approximately $10,936,000 of net proceeds and $177,500 in cash reserves to the creditor, who cancelled the nonrecourse debt. …

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