July 30, 2020 12:15 am

Cancellation of Loan from Employer not Tax Free

An executive received a $500,000 interest-free loan from a company that hired her and had her relocate from Massachusetts to California. The money was meant to help her buy a home in the new location, which she did. She was later laid off, the note for the loan was called, and she negotiated a settlement. It included loan forgiveness of part of the principal, with the balance secured by a deed of trust in favor of the company. She did not report the canceled debt on the grounds that it was qualified principal residence indebtedness, the forgiveness of which is not includible in gross income.

The Tax Court rejected the taxpayer’s position (Weiderman, TC Memo 2020-109). To be qualified principal residence indebtedness, the loan must be secured by the home. The fact that the home was later used to secure the remaining debt did not transform the original loan into qualified principal residence indebtedness.

Note: The exclusion from gross income from the cancellation of principal residence indebtedness had expired at the end of 2017. It was extended for 2018, 2019, and 2020. Taxpayers who reported canceled home mortgage debt on 2018 returns can filed a refund claim.

Tax Glossary

Lump-sum distribution

Payments within one tax year of the entire amount due to a participant in a qualified retirement plan. Qualifying lump sums may be directly rolled over tax free, or, in some cases, are eligible for current tax under a favorable averaging method.

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