8125 / Is it possible that the tax consequences of a foreclosure, short sale or deed in lieu of foreclosure could result in a taxable loss and discharge of debt income?

Example: Assume Asher purchased a commercial building totally funded with the proceeds of a $100,000 recourse loan secured by the building. Several years later when the principal amount of loan was still $100,000, Asher defaulted on the loan and the lender foreclosed on the property. At that time, the fair market value of the building was $80,000 and the adjusted basis of the building was $90,000 (original basis reduced by $10,000 of depreciation deductions). After crediting the fair market value of the property against the outstanding balance of the loan, the lender chooses to forgive the $20,000 shortfall for no consideration. Because the fair market value of the property was only $80,000, it is as if Asher sold the building to the lender for $80,000 which he, in turn, used as a partial repayment of the loan. Since the basis of the building was $90,000, Asher has a $10,000 taxable loss pursuant to IRC Section 165 ($90,000 basis minus $80,000 basis). The $20,000 remaining balance written off by the creditor would be considered discharge of debt income under IRC Section 61(a)(12).