8515 / Is a taxpayer’s discharge of indebtedness taxable?
Editor’s Note: Congress extended the treatment of qualified principal residence indebtedness, discussed below, through the 2025 tax year. Congress has not yet extended this treatment for tax years beyond 2025.If a creditor of a taxpayer discharges all or part of a debt for no consideration, the amount of debt discharged is potentially taxable to the taxpayer.2 However, such debt discharge is excluded from gross income; and, thus not taxable, if the discharge: (1) occurs in a bankruptcy; (2) occurs when the taxpayer is insolvent and the discharge does not render the taxpayer solvent; (3) the indebtedness discharged is “qualified farm indebtedness;”3 (4) in the case of a taxpayer other than a C corporation, the indebtedness discharged is “qualified real property business indebtedness;” or (5) the indebtedness discharged is “qualified principal residence indebtedness” (see “Mortgage Forgiveness Debt Relief Act of 2007,” below) that is discharged before January 1, 2026 (but see editor’s note, above).4
Importantly, as stated above, “discharge of debt income” is triggered when a debt is forgiven for no consideration. Therefore, if any consideration is involved, it would not be considered discharge of indebtedness income. Significantly, under those circumstances, the so-called discharge is completely taxable as none of the above exclusions would apply.
Example: Asher borrows $10,000 from his employer. Instead of repaying the loan, his employer forgives the debt after Asher works 200 hours of overtime. In other words, it is as if the employer paid Asher $10,000 for his services; which, Asher, in turn used to repay the loan. Thus, the discharge of the loan is essentially compensation for services, or taxable wage income (not discharge of debt income).