Both Sally and Ed Own Property with a Fair Market

question 10

Essay

Both Sally and Ed 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.Each of them was 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, the net worth of each has increased as measured using the cost basis in the assets.Each taxpayer also
experienced a loss in the value of her or his 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, the tax law in effect through 2017 allows the taxpayer whose property is a personal residence to exclude the income from debt discharge from gross income.The taxpayer who
a.Explain whether each of these individuals has realized income from the reduction in the debt.
b.Assume that under the current system of measuring income, each of these taxpayers realized
income from the reductions in the mortgages.Should either of these taxpayers be permitted
to exclude any of the debt discharge income?

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Definitions:

Appraised Value

Represents the estimated monetary value of a property as determined by a qualified appraiser based on its characteristics and the selling prices of comparable properties.

Property Taxes

Levies imposed by a government on property owners based on the assessed value of their property.

Compounded Monthly

The process where the interest earned on an investment is added to the principal each month, so that the interest for the next month is calculated on the total.

Interest

The cost of borrowing money, typically expressed as a percentage of the amount borrowed over a period of time.