This is a conceptual question, but I have included a sample set of facts to set the stage:

  • Bank loans $200k to Individual A to purchase home.
  • Individual A pays the loan down by $20k, but eventually defaults.
  • Bank repossesses home, which is now worth $100k and cancels the remainder of Individual A's $180k debt.

One potential tax consequence is that Individual A may report a net loss of $20k because the amount realized is the quantity of the outstanding debt ($180k), and the basis would be $200k.

Another potential consequence is that Individual A must report a gain of $80k because the bank has canceled that quantity of Individual A's debt.

I believe that the former is technically correct, but that answer seems inconsistent with the positive economic result of the transaction. Any help understanding this apparent inconsistency would be much appreciated.

  • Please add a tag for the tax jurisdiction to the question.
    – Barmar
    Commented May 3 at 21:08

2 Answers 2


If this is the person’s primary place of residence, there are no capital gains tax implications because the family home is not taxable.

If this is not the person’s primary place of residence, they have suffered a capital gains tax loss of $100,000 (property bought for $200,000 and realised for $100,000). Capital losses can only be applied against capital gains, not income so, unless the person has also made a gain somewhere else (shares, bonds, other properties etc.) they cannot reduce their tax liability. The good news is that this loss can be carried forward to offset future capital gains.

Either way, they have a revenue gain of $80,000 ($180,000 loan of which $80,000 is forgiven after the bank gets the $100,000 from the sale). That said, it would not be normal in Australia for the bank to forgive the debt and this would be due and payable. The bank is likely to enter a repayment agreement, but if that can’t be done, here comes personal bankruptcy.

If this is their home, this is not assessable income. If it’s an investment then it is subject to income tax in the current year.


IRS Tax Topic 431, Canceled debt – Is it taxable or not?

In general, if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable. If taxable, you must report the canceled debt on your tax return for the year in which the cancellation occurred.

Caution: If your debt is secured by property, and the creditor takes that property in full or partial satisfaction of your debt, you are treated as having sold that property to the creditor. The tax treatment of the deemed sale depends on whether you were personally liable for the debt (recourse debt) or not personally liable for the debt (nonrecourse debt).

For recourse debt, your amount realized on the sale is the fair market value (FMV) of the property. The difference between FMV and your adjusted basis (usually your cost) will be a gain or loss on the disposition of the property. Your ordinary income from the cancellation of the debt is the amount by which the discharged debt exceeds the FMV of the property. Include this cancellation of debt in gross income unless an exception or exclusion, discussed below, applies.

For nonrecourse debt, your amount realized is the entire amount of the nonrecourse debt, plus the amount of cash and the FMV of any non-cash property you received. You will not have ordinary income resulting from debt cancellation.

Most (but not all) mortgages are recourse debt, meaning they can go after your other assets. Thus, in the example, you have taxable ordinary income of $80k. The loss on the sale of your personal home is not deductible.

If you had a rare non-recourse mortgage, your basis would be $200k, a cancellation of $180k of debt, and therefore a capital loss of $20k.

As you can see, both cases can happen.

  • Thank you for the thorough answer.
    – user56567
    Commented May 3 at 5:19
  • Home mortgages for primary residence are non-recourse in 12 states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington. Basically all of the west coast, and some others. Given that both California and Texas are in the list, it should give a pretty large portion of the overall loans in the US.
    – littleadv
    Commented May 3 at 5:37
  • The misses an important point: Discharge of indebtedness income isn't taxable to the extent that the discharged debt exceeds the taxpayer's net worth (i.e. that the taxpayer is insolvent). answerconnect.cch.com/topic/5762b86e7c6b1000871890b11c2ac4f102/… This is often the case (at least partially) in a recourse debt foreclosure situation. Few people who are foreclosed upon have more than about $20,000 of personal property, most have only minimal financial assets, and many people who are foreclosed upon have other debts for credit cards, student loans, health care, etc.
    – ohwilleke
    Commented May 3 at 21:50

You must log in to answer this question.