Question

Jimmy has fallen on hard times recently. Last year he borrowed $285,000 and added an additional $62,500 of his own funds to purchase $347,500 of undeveloped real estate. This year the value of the real estate dropped dramatically, and Jimmy’s lender agreed to reduce the loan amount to $257,600. For each of the following independent situations, indicate the amount Jimmy must include in gross income:

A. The real estate is worth $195,900 and Jimmy has no other assets or liabilities.

Amount Includible ______

B. The real estate is worth $267,500 and Jimmy has no other assets or liabilities

Amount Includible ?_______

c.The real estate is worth $220,900 and Jimmy has $53,200 in other assets but no other liabilities

Amount Includible ?______

Answer 1

Solution:

a. Amount includible = $0

The loan reduction generates $27,400 of income from discharge of indebtedness, but this income is excludable for Jimmy because he is still insolvent even after the reduction in loan. His net worth = Total assets $195,900 - Total liabilities $257,600 = -$61,700.

b. Amount includable = $9,900.

The loan reduction generates $27,400 of income from discharge of indebtedness, but after reduction he becomes solvent and has net worth of $267,500 - 257,600 = $9,900. So, only this amount is includable in his gross income and he can exclude rest amount of reduction.

c. Amount includable = $16,500.

The loan reduction generates $27,400 of income from discharge of indebtedness, but after reduction he becomes solvent and has net worth of $220,900+ 53,200 - 257,600 = $16,500. So, only this amount is includable in his gross income and he can exclude rest amount of reduction in debt.