Nov 7th, 2022
Apr 1st, 2020
The economic standstill brought about by the recent pandemic has led some individuals and businesses in precarious financial situations and pushed others to the brink of insolvency. If faced with foreclosure or the need to restructure their debts, taxpayers should seriously consider potential adverse tax consequences in order to avoid compounding existing financial hardship. Two particularly relevant areas to bear in mind are the rules relating to acquisition or reacquisition by creditors of property given as security and the total or partial forgiveness of debt.
Section 79 of the Income Tax Act (the Act) deems a debtor to have disposed of a property when that property is acquired or reacquired by the creditor and the debt is extinguished. For example, if following a debtor’s inability to pay their mortgage, the bank acquires the ownership of the property given as collateral on the debt, the debtor will be deemed to have disposed of that property and could thus realize a capital gain or income, or, conversely, a capital loss or loss on account of income , depending on the nature of the property.
Under section 79 of the Act, the proceeds of disposition are calculated according to a formula taking into account multiple factors such as the number of debts relating to the property and the fair market value of each property, if more than one property was given as security for the same debt. However, in a simple case, the proceeds of disposition would essentially correspond to the unpaid amount of principal and unpaid accrued interest.
Depending on the adjusted cost basis of the property to the debtor, the deemed disposition of the property could result in a gain or loss. Finally, note that if the debtor were to make subsequent payments on the debt for which the property was given as security, the debtor could claim a deduction or a capital loss.
Section 80 of the Act can reduce some tax attributes or add to the income of a debtor in favor of whom a debt was entirely or partially forgiven. Section 80 of the Act applies to a debt that is defined as a commercial obligation, that is, generally speaking, a debt in relation to which the debtor could claim a deduction for interests paid.
In a predetermined order, the amount forgiven on the debt in favor of the debtor could reduce the debtor’s non-capital losses, allowable business income losses, and net capital losses, and other classes of losses if the debtor so chooses. If a portion of the forgiven amount remains, 50% of the remaining portion will be included in the debtor’s income. Alternatively, the debtor can choose to transfer any remaining portion of the forgiven amount to an eligible transferee, such as a subsidiary or a parent corporation.
Finally, note that most amounts included in the proceeds of disposition of a property given as security under section 79 of the Act would not be included in the computation of the forgiven amount under section 80 of the Act.
In sum, it is crucial for taxpayers to consider the tax implications of foreclosure or the restructuring of their debts with their creditors, since the collection of a security by a creditor or the total or partial forgiveness of a debt could have a serious impact on the debtor’s tax attributes and even increase their taxable income.
For further questions or to discuss particular tax issues, feel free to contact the author.