Sally and Ed Each Own Property with a Fair Market

question 103

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.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:

Restrictive Short-term Policy

A financial policy aimed at minimizing the amount of working capital to reduce short-term financing costs, often at the risk of running low on liquidity.

Current Assets

Assets that are expected to be converted into cash, sold, or consumed within one year or within the normal operating cycle of the business, whichever is longer.

Cash Flow Time Line

A visual representation that maps out all cash inflows and outflows of a project or investment over time.

Operating Cycle

The period from when a company acquires inventory to when it collects cash from the sale of that inventory, indicating the efficiency of a company's operations.