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available from January 1, 2007 through 2013. The Emergency Economic Stabilization Act of 2008 extended this provision for three more years. A taxpayer whose principal residence has declined in market value will be able to refinance the loan without incurring a tax on the debt forgiveness. The American Taxpayer Relief Act of 2012 extends this provision through December 31, 2013.Purchase Money DebtsIf a debt owed to the seller for the purchase of property is reduced by the seller, then no income is recognized by the purchaser. The reduction is a purchase price adjustment, not a discharge in indebtedness. Consequently, the purchaser recognizes no income even though the obligation has been reduced. In order for this rule to apply, there must be a “pure” cancellation of indebtedness income; the only relationship between the parties must be that of debtor and creditor, and the
debt forgiveness must not simply be the method by which the creditor makes a payment to the debtor for services or property. Code Sec. 108(e)(5).Corporate DebtsA shareholder’s gratuitous forgiveness of the corporation’s indebtedness or cancellation of the corporation’s indebtedness to the shareholder is usually considered a contribution of capital to the corporation to the extent of the principal debt. Code Sec. 108(e)(6); Reg. §1.61-12(a).EXAMPLE 4.32 Benjamin Warren is sales manager and shareholder of Cleveland Widget Inc. The company is in bankruptcy and Benjamin has not been paid for several months. Benjamin agrees to cancel the debt for the unpaid wages. Cleveland Widget Inc. recognized no income; instead, the cancellation is treated as a contribution of capital. Benjamin, who is on the cash basis, recognizes no income from the unpaid wages.The American Recovery and Reinvestment Act of 2009 allows certain businesses to recognize gross income from the cancellation of debt over five years beginning in 2014. The types of debt instruments covered by the Act include bonds, debentures, notes, certificates, and other types of debentures issued by a corporation in connection with a trade or business. The debt instrument must have been repurchased by the corporation after December 31, 2008, and before January 1, 2011.Student LoansA special income exclusion applies to the discharge of all or part of a student loan under a governmental agency student loan program if, pursuant to the loan agreement, the discharge is made because the individual works for a specified period of time in certain geographical areas for certain classes of employers (e.g., as a doctor or nurse in a rural area). Code Sec. 108(f). The amount of the loan that is forgiven is excluded from gross income.KEYSTONE PROBLEMRoy and Ann are students at one of the country’s finest state universities and wish to marry in the near future. Roy has inherited a potato farm from his late grandfather. Both have scholarships and part-time jobs. They will receive as gifts, property (a small house), and some stocks and bonds. Further, both have cash from savings and investments (about $10,000). Roy is also in debt ($5,000)