Tax Brake with Robert G. Nath, Esq.

The debt involved is bona fide debt, that is, real debt and not contingent debt like a guarantee. And even if its from Uncle Rich, the forgiveness can still be taxable to you.

The general rule is that any forgiveness of bona fide debt is gross income to the beneficiary. The tax laws provide several exceptions to this. The most important are: no gross income if you are “insolvent” and no gross income if you are in bankruptcy.

Insolvent means an excess of liabilities over assets, determined just before the forgiveness. So if you have $1,000,000 of debt to be forgiven and all other assets and liabilities netting to $900,000, you are “insolvent” for this purpose. But be careful: the forgiveness extends only to that $100,000 in this example.

Bankruptcy is the other official “forgiveness” basis. Here, you are discharged by reason of the bankruptcy from a debt. The tax laws say you don't have to report that discharge as income, because that would defeat the whole purpose of the bankruptcy.

In all cases, however, you must pay a “price” for the debt discharge. The price is: You reduce the basis of other assets. The tax laws are very complex in this regard, but the effect of them is simply to postpone, rather than permanently exclude, the debt discharge.

If you have one of these situations, it's best to consult a professional since the rules can be tricky.

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