Edward and Inez purchased their home in 2008 for $600,000. They financed the purchase with a $550,000 mortgage. In 2018, they fall upon hard times and cannot make the mortgage payments. They sell their home for $425,000. At the time of the sale, the mortgage balance is $450,000 on their home. The mortgage company cancels the remaining debt. Which of the following is true?

I. Edward and Inez will recognize no income on the cancellation of the mortgage loan.
II. Edward and Inez will realize a loss on the sale of their home.

Question

Edward and Inez purchased their home in 2008 for $600,000. They financed the purchase with a $550,000 mortgage. In 2018, they fall upon hard times and cannot make the mortgage payments. They sell their home for $425,000. At the time of the sale, the mortgage balance is $450,000 on their home. The mortgage company cancels the remaining debt. Which of the following is true?
​
I. Edward and Inez will recognize no income on the cancellation of the mortgage loan.
II. Edward and Inez will realize a loss on the sale of their home.
​
​

Quizplus · Accepted Answer

Edward and Inez will realize a loss on the sale of their home because they sold it for less than the purchase price ($425,000 sale price vs. $600,000 purchase price). Additionally, the cancellation of the remaining mortgage debt ($450,000 mortgage balance with $425,000 from the sale) could be considered as income (cancellation of debt income), but under certain circumstances (like insolvency or if the debt is qualified principal residence indebtedness and other exceptions under the Mortgage Forgiveness Debt Relief Act, if applicable), it might not be recognized as income. Therefore, without specific exclusions, the general rule would lead to recognizing income, but given the context and potential exceptions, statement I could be considered correct under specific circumstances, making both statements correct in a general context.

Edward and Inez Purchased Their Home in 2008 for $600,000