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Federal Income Tax

Loans and Debt Cancellation

Loans and Debt Cancellation

Learn why borrowed money isn't income to the borrower (until it is) and why the distinction between principal and interest matters for both borrower and lender.


In this lesson, we'll examine the federal income-tax consequences flowing from a typical lending transaction. To start, we'll outline four basic rules to always keep in mind whenever the Internal Revenue Code and lending transactions collide. Then, we'll explore the general rule that cancellation of debt, or COD, represents gross income to the debtor. Finally, we'll study some exceptions to the general rule that COD income is gross income.

Basic Rules for Lending Transactions

First, borrowed...