Owners of Distressed Properties May Qualify For Debt Reduction or Even Cancellation

Cancellation of debt income (CODI) from distressed property is becoming more prevalent; yet one more effect of today’s lagging economy. As discouraging as the situation may be, there are several ways to minimize the tax impact of debt forgiveness or debt restructuring.

The general rule is that CODI must be included in taxable income. However, there are provisions in the tax law that allow for the exclusion of CODI to individuals and businesses. Taxpayers that may benefit from these provisions include real property owners that have:

  • filed for bankruptcy
  • demonstrated they are insolvent, or
  • qualified real business property indebtedness

If you have distressed property, there are also other consequences that CODI may have on your specific tax situation. If the CODI is excluded from your taxable income, your tax attributes must be reduced, which may mean a reduction of net operating losses, general business credits, and capital loss carryovers to name a few.

Contact your tax professional early in a situation of distressed property. They can recommend an action plan and ideal timing of events to either minimize or eliminate your tax implications. Your tax professional can also help you negotiate with lenders. Many lenders would rather work with the taxpayer to reach an agreement than to go through the cost of a foreclosure. There are multiple scenarios in which the lenders and taxpayers walk away relatively unscathed. But, you need to be proactive to achieve a favorable outcome.