TaxFinance
Cancellation of Indebtedness Income
Also known as: COD income, debt forgiveness income, cancellation of debt income
Ordinary income a borrower owes when a debt is settled or forgiven for less than its face value. In a seller-financed deal the borrower is the buyer — so a written-down seller note creates income for the buyer, not the seller.
WHY IT MATTERS
Cancellation-of-debt income exists only where there's a real debtor-creditor relationship, and it's taxed to the debtor — the party relieved of paying. In a seller-financed deal the buyer is the borrower and the seller is the lender. So if the buyer settles a $15M note for $8M, the $7M of forgiveness is the buyer's income, not the seller's. The seller's side looks different: having collected less than face value, the seller has a reduced gain or a bad-debt loss, not COD income. Founders sometimes hear "debt-forgiveness income" attached to a discounted payoff and assume the tax is theirs — on a seller note, it isn't. The discount still hurts, though, because they may have already paid tax on gain they're now not going to collect.