February 9, 2021 - Douglas Myser

Debt cancelled was not qualified debt. This is an article in our ongoing Tax Court education series. In the case of Weiderman v. Commissioner, the taxpayer found that simply using a loan to purchase a residence is not sufficient to make it into qualified principal residence indebtedness. The taxpayer was looking to claim an exclusion from cancellation of indebtedness income under IRC Section 108 (a)(1)(e). Under the terms of her employment offer, K-Swiss agreed to assist the Weiderman's in their relocation to California, providing them with a $500,000 interest free loan to help finance the purchase of a new residence. K Swiss and Mrs. Weiderman later executed a promissory note, date February 15, 2007, which discussed the terms and conditions of the loan including that the loan was due and payable in full in one lump sum payment on the earlier of February 15, 2017, or the effective date of her termination whether voluntary or non-voluntary. After the loan disbursements, the Weiderman's used the loan proceeds to purchase a residence in California. Debt cancelled was not qualified debt.

But on December 1, 2008, K-Swiss terminated Mrs. Weiderman's employment. Accordingly, K-Swiss demanded full payment of the $500,000 loan. Ultimately Mrs. Weiderman and K-Swiss agreed through various settlement negotiations, that K-Swiss would cancel $285,000 of the loan with the proceeds from the sale of the California residence satisfying the remaining loan balance. Qualified principal indebtedness exclusion of cancellation of indebtedness income. A provision that was originally temporary added as part of the economic relief packages that were enacted as a reaction to the 2008 real estate crash, the exclusion from income for cancellation of indebtedness on qualified principal residence debt has been extended multiple times, most recently as part of the 2019 end of year tax package.

Under the tracing rules applicable to interest, the taxpayer was allowed to trace $385,993 of the employer loan as being used to acquire the residence. But merely using the debt to acquire the residence is not enough to qualify the debt as acquisition indebtedness.