Question

Problem 5-57 (LO. 4)

Vic, who was experiencing financial difficulties, was able to adjust his debts as follows:

a. Vic is an attorney. Vic owed his uncle $25,000. The uncle told Vic that if he serves as the executor of the uncle's estate, Vic's debt will be canceled in the uncle's will.

The $25,000 debt cancellation is Vic's gross income when the uncle dies.

b. Vic borrowed $80,000 from First Bank. The debt was secured by land that Vic purchased for $100,000. Vic was unable to pay, and the bank foreclosed when the liability was $80,000, which was also the fair market value of the property.

Vic has a $ gain as a result of the foreclosure.

c. The Land Company, which had sold land to Vic for $80,000, reduced the mortgage on the land by $12,000.

The $12,000 reduction in the debt is Vic's gross income because the debt reduction was made by the seller of the property.

Answer 1

a) Vic's uncle (creditor) had cancelled Vic's debts in his will. If the creditor reduces the debt as an act of love, affection, or generosity, the debtor has simply received a non-taxable gift. The cancellation of Vic's debt by his uncle falls under this category and hence it is non-taxable gift.

b) Vic's gain on account of foreclosure = $20,000 ($100,000 - $80,000). $20,000 should be accounted by Vic as gain on foreclosure

c) Gain on mortgage of land = $68,000 ($80,000 - $12,000). $68,000 should be accounted by Vic as gain on mortgage of land.