8114 / Is discharge of debt specifically included in gross income?

As discussed in Q 8113, the discharge of debt is an economic benefit conveyed upon the debtor. In essence, a discharged debt is equivalent to receiving money (i.e., the amount borrowed that will never be repaid). The context in which the debt is discharged will determine how it is to be reported. Assuming the forgiven debt is a “pure” discharge, however, it is deemed to be “income from discharge of indebtedness” specifically includible in gross income pursuant to IRC Section 61(a)(12). For this purpose, pure discharge of debt requires an unconditional forgiveness for no consideration.

Example: Asher borrows $10,000 to take a two-week European vacation. Two years later, when the loan becomes due, Asher defaults. In lieu of pursuing a legal collection action against Asher, the lender forgives the entire loan. Because the forgiveness of the loan was unconditional for no consideration from Asher, the $10,000 forgiveness is considered to be “income from discharge of indebtedness” includible in gross income under IRC Section 61(a)(12).