Summary: 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 OfficerFollow me on Twitter @GlobalMarketUpd
