Debt and Taxes

Can we forgive our way back to prosperity?

Imagine this: you’re underwater on your mortgage and out of a job. You’ve been struggling to make payments on your home, but you’re not sure you can make it. You’re considering a short-sale and other options. Then you get a notice from a group called “Rolling Jubilee” that they have purchased your mortgage and forgiven it. You’d be delirious, right?

Well, maybe. Because that lovely act—debt forgiveness—is a taxable event. That is, forgiving a $200 thousand mortgage creates taxable income of $200 thousand. This group solicits tax-free donations, buys troubled debt at a discount, and forgives the loans. They maintain that they’re not making any money from the debt cancellation, so they don’t need to file any paperwork. But the IRS may have a different take.

Because when a bank takes a loss a loan, they deduct that loss as a business expense. Any subsequent recovery is income. It makes no difference whether that recovery is earned by a hedge fund speculating or by a homeowner who is unexpectedly mortgage-free. Debt forgiveness is income. Otherwise we could have our employers make “loans” to us every paycheck and then “forgive” the loans. Cute, but wrong.

But you’d happily exchange a $200 thousand debt to a bank for a $56 thousand debt to the IRS, right? Again, maybe. The IRS has a lot more collection muscle than Bank of America. And tax obligations typically survive the bankruptcy process.

Which brings up my final point: we already have a perfectly fine debt-forgiveness process. It’s called bankruptcy. It’s legal, orderly, and doesn’t create new tax obligations. Well-meaning but misinformed folks like Rolling Jubilee need to do their homework. Because the Devil—or in this case, the IRS—is in the details.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By |2014-09-09T10:50:25-04:00November 15th, 2012|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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