Is it true that a borrower can get taxed for the debt forgiven through loan write-offs, write-downs and foreclosures?
Yes. IRS Section 108 governs the taxability to borrowers of losses, write-offs and write-downs by lenders, i.e. “phantom gain.” Borrowers can be liable for income taxes for these excused debts. IRC 108 should be consulted for each application, but, in general, debts for which the only recourse is the property are not considered “phantom gain” when defaulted and written off. Debts which maybe pursued personally against the borrower are eligible for “phantom gain” treatment. Currently, “phantom gains” on purchase money debts against residential property which the debtor occupies—whether or not recourse—are exempt from taxation under a federal law up to $2 million in gain. There are other exemptions. The debtor should contact a licensed professional for advice and applicability in this area.
