If the creditor reduces the debt as an act of love, affection, or generosity, the debtor has simply received a nontaxable gift.
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5. If another person cancels or pays your debts, but not as loan or gift, have you constructively received this amount, and generally must you include it in your gross income, for the year?
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Donald debtor borrowed $10,000 from Claire Creditor a few years ago. The loan was unsecured, bore adequate interest that has been paid by Donald, and was used by Donald to purchase a variety of consumer goods for personal use. However, Donald has now fallen on hard times. He owes his creditors, including Claire, $100,000, but he has only $95,000 of assets, consisting of the following: $7,500; and a condominium in which he lives that has a fair market value of $80,000 and a basis of $50,000. Donald has asked Claire if he can make some arrangement to reduce the amount of the debt. How much gross income must Donald report under the following alternative arrangements with Claire? 1. Donald pays Claire $7,500, and Claire cancels the promissory note. 2. Donald transfers 100 shares of stock of Specific Motors Corp (which has an aggregate FMV of $7,500 and a basis of $5,000) to Claire, and Claire cancels the promissory note. What will be Donald's basis in his condominium after this transaction? 3. Donald, who is a carpenter, performs renovation work on Claire's house. Normally, Donald would charge $7,500 for these services, but instead Claire cancels the promissory note.
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