What happens to all the debt built up during the crisis?

Imagine: you’re underwater on your mortgage and out of a job. You’re struggling to make the payments, but you’re not sure you can make it. What are your options? You get a notice from a group called “Rolling Jubilee” that they have purchased your mortgage and forgiven it. You’re deliriously happy, right?

Well, maybe. Because that lovely, generous act — debt forgiveness — is taxable. Forgiving a 200 thousand dollar mortgage creates taxable income of 200 thousand dollars. Rolling Jubilee solicits tax-free donations, buys troubled debt at a discount, and forgives the loans. They maintain that they’re not making any money from the debt cancellation, so they don’t need to file any paperwork. But the IRS may have a different take.

When a bank writes off a loan, they deduct that loss as a business expense. Any subsequent recovery is income. It makes no difference whether that recovery is earned by a hedge fund speculating or by a homeowner who is unexpectedly mortgage-free. Debt forgiveness is income. Otherwise sharp operators would game the system with loans and forgiveness and other shenanigans.

But you’d happily exchange a $200 thousand debt to a bank for a $56 thousand debt to the IRS, right? Maybe. The IRS has a lot more collection muscle than Bank of America. And tax obligations don’t usually go away in bankruptcy.

So remember: we already have a perfectly fine debt-forgiveness process. It’s called bankruptcy. It’s legal, orderly, and doesn’t create new tax obligations. Well-meaning but misinformed folks like Rolling Jubilee need to do their homework. Because the Devil — or the IRS — is in the details.