Tax Consequences of Debt Forgiveness

| Cascade CPAs |

Memo

To: | Tax Staff (you) |

From: | Jack Tax, CPA (Tax Partner) |

Date: | October 22, 2015 |

Re: | Tax Consequences of Debt Forgiveness |

| |

One of our individual tax clients, Joe Default, received a notice of deficiency from the IRS related to alleged failure to report income related to debt forgiveness on his 2008 tax return (Form 1040). Joe received a 1099-C in 2008 for $50,000 related to forgiveness of a home equity line of credit. Joe did not report the debt forgiveness as income on this 2008 tax return with the rationale that the debt forgiveness was related to his primary residence, and therefore should be excluded from taxable income.

Additional facts related to Joe’s situation are:

* Joe previously owned a home in Texas that was collateral/security for the home equity line of credit (amount of $50,000 forgiven).

* The proceeds from the home equity line of credit ($50,000) was used to make improvements to Joe’s new home in Oregon where he recently moved for a new job.

* After moving to Oregon in early 20008, Joe’s home in Texas became worth less than his mortgage and home equity line of credit combined. Joe worked with the bank to sell the home at auction through foreclosure proceedings for a value less than the combined mortgage and home equity balances. As a result, the related home equity line of credit debt of $50,000 was forgiven as part of the foreclosure process.

The following questions should be analyzed as part of your research at minimum:

* Should Joe have reported the debt forgiveness reported on 1099-C of $50,000 as income on this tax return?

* What possible reasons would the IRS have for challenging the exclusion of Joe’s debt forgiveness on his primary residence?

* Based on your research, is the IRS position correct in that Joe should have reported the $50,000 income?

Please provide your findings to me in the form of a professional memo. The following sections are required...