Jolie purchased her residence in 2012 for $500,000 by borrowing $450,000. In 2018, she becomes unemployed and can no longer afford to make the full monthly payment on the mortgage. When the mortgage balance is $430,000, the bank agrees to reduce her mortgage to avoid foreclosure. Jolie is insolvent before and after the mortgage reduction. What is Jolie's basis in her residence if the bank agrees to reduce the mortgage on the residence to $300,000?

Question

Quizplus · Accepted Answer

Jolie's basis in her residence is the amount she paid for the property plus any improvements (not including repairs) minus any depreciation taken. 
In this case, her initial basis was $500,000. When the mortgage is reduced to $300,000, Jolie receives a debt forgiveness of $130,000 ($430,000 initial mortgage balance - $300,000 reduced mortgage), and she remains insolvent after the reduction. Therefore, she should exclude the forgiveness of debt income from her income tax return up to the extent of her insolvency ($500,000 initial basis - $430,000 initial mortgage balance = $70,000 insolvency at the time of the mortgage reduction). 
As a result, her new basis for her residence would be $370,000 ($500,000 - $130,000 excluded income). Therefore, the correct answer is option C.

Jolie Purchased Her Residence in 2012 for $500,000 by Borrowing