Home Blog IRC 108 (Explained: What It Is And What You Should Know)

IRC 108 (Explained: What It Is And What You Should Know)

What is IRC 108?

Will the cancellation of debt be considered as an income?

What should you know about IRS Section 108?

Keep reading as we have gathered exactly the information that you need!

Let me explain to you 26 U.S. Code § 108 and when paying off debt will not be considered an income!

Are you ready?

Let’s get started!

What Is IRC 108

IRC 108 refers to Section 108 of the Internal Revenue Code titled “Income from discharge of indebtedness”.

Generally, funds you borrow are not considered as income for tax purposes.

However, there are instances when the discharge of debt will result in the borrower having to pay taxes.

For instance, if the borrower’s debt is discharged without the borrower making payment, the amount that was discharged will be recognized as income to the borrower.

IRC 61(a)(12) defines gross income to include income from the discharge of indebtedness.

As a result, when a borrower is looking to have his or her credit discharge debt to reduce financial burden, unless the borrower can benefit from an exception to pay taxes, income tax will be owed and should be accounted for.

IRS Code 108 outlines the different exceptions to the rule that income from the discharge of debt should be taxed.

IRC Section 108 presents the following rule:

Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if (A)the discharge occurs in a title 11 case, (B)the discharge occurs when the taxpayer is insolvent, (C)the indebtedness discharged is qualified farm indebtedness, (D)in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or (E)the indebtedness discharged is qualified principal residence indebtedness which is discharged (i)before January 1, 2026, or (ii)subject to an arrangement that is entered into and evidenced in writing before January 1, 2026.

To get a sense of what IRC 108 entails, let’s look at an overview of this complex provision.

IRC 108 Overview

IRC Sec 108 is a long provision outlining the rules relating to the forgiveness or discharge of debt.

To give you an idea of what it contains, below is an extract of the different paragraph and subparagraph headings found in 108 IRC:

  • IRC 108(a) Exclusion from gross income
    • (1)In general
    • (2)Coordination of exclusions
    • (3)Insolvency exclusion limited to amount of insolvency
  • IRC 108(b) Reduction of tax attributes
    • (1)In general
    • (2)Tax attributes affected; order of reduction
    • (3)Amount of reduction
    • (4)Ordering rules
    • (5)Election to apply reduction first against depreciable property
  • IRC 108(c) Treatment of discharge of qualified real property business indebtedness
    • (1)Basis reduction
    • (2)Limitations
    • (3)Qualified real property business indebtedness
    • (4)Qualified acquisition indebtedness
    • (5)Regulations
  • IRC 108(d) Meaning of terms; special rules relating to certain provisions
    • (1)Indebtedness of taxpayer
    • (2)Title 11 case
    • (3)Insolvent
    • [(4)Repealed
    • (5)Depreciable property
    • (6)Certain provisions to be applied at partner level
    • (7)Special rules for S corporation
    • (8)Reductions of tax attributes in title 11 cases of individuals to be made by estate
    • (9)Time for making election, etc.
    • (10)Cross reference
  • IRC 108(e) General rules for discharge of indebtedness (including discharges not in title 11 cases or insolvency)
    • (1)No other insolvency exception
    • (2)Income not realized to extent of lost deductions
    • (3)Adjustments for unamortized premium and discount
    • (4)Acquisition of indebtedness by person related to debtor
    • (5)Purchase-money debt reduction for solvent debtor treated as price reduction
    • (6)Indebtedness contributed to capital
    • (7)Recapture of gain on subsequent sale of stock
    • (8)Indebtedness satisfied by corporate stock or partnership interest
    • (9)Discharge of indebtedness income not taken into account in determining whether entity meets REIT qualifications
    • (10)Indebtedness satisfied by issuance of debt instrument
  • IRC 108(f) Student loans
    • (1)In general
    • (2)Student loan
    • (3)Exception for discharges on account of services performed for certain lenders
    • (4)Payments under national health service corps loan repayment program and certain state loan repayment programs
    • (5)Special rule for discharges in 2021 through 2025
  • IRC 108(g) Special rules for discharge of qualified farm indebtedness
    • (1)Discharge must be by qualified person
    • (2)Qualified farm indebtedness
    • (3)Amount excluded cannot exceed sum of tax attributes and business and investment assets
  • IRC 108(h) Special rules relating to qualified principal residence indebtedness
    • (1)Basis reduction
    • (2)Qualified principal residence indebtedness
    • (3)Exception for certain discharges not related to taxpayer’s financial condition
    • (4)Ordering rule
    • (5)Principal residence
  • IRC 108(i) Deferral and ratable inclusion of income arising from business indebtedness discharged by the reacquisition of a debt instrument
    • (1)In general
    • (2)Deferral of deduction for original issue discount in debt for debt exchanges
    • (3)Applicable debt instrument
    • (4)Reacquisition
    • (5)Other definitions and rules
    • (6)Special rule for partnerships
    • (7)Secretarial authority

Cancellation of Indebtedness Rules

Let’s look at some statutory exclusions of the cancellation of indebtedness income.

Acquisition of Debt By Related Party

When a person purchases his or her own debt from a related party by paying less than what was owed, then the seller of the debt will have a cancellation of debt income.

Debt Contributed to Capital

In some cases, contributions of corporate debt to capital can result in COD income to the corporation.

For instance, if a corporation acquires its debt from a shareholder by treating it as a contribution to capital, it is considered that the corporation satisfied its debt.

In that case, Section 118 setting out the rule that contributions to corporate capital are excluded from income tax will no longer apply to the corporation.

Debt-for-Debt Exchanges

Another instance where the debtor will realize COD income is when the debtor buys back its debt at a discount.

In other words, if a debtor repurchases debt at a price lower that its adjusted issue price, the debtor will realize an income.

Disposition of Property Security Debt

When there is the disposition of property security debt and the debt is discharged, the nature of the debt will determine if the property owner will have any tax exposure or not.

For example, in the context of a voluntary conveyance of property or the foreclosure of property to satisfy recourse debt, if the property is sold above its fair market value and where the debt discharged is above the fair market value, the debtor will have an income tax to pay.

If the property is sold at fair market value but below the property owner’s adjusted basis, then the owner will have a loss to report on the property.

Exceptions To The IRS Code Section 108 Rule

Let’s look at some exceptions that you will find to the IRS Section 108 cancellation of debt rule.

Contingent or Contested Liabilities

The cancellation of a contingent liability will generally not result in the debtor having any COD income to report.

The principle behind this is that a contingent liability was not truly “debt” for the purposes of debt cancellation.

For example, the obligation to make future payments resulting from the profits earned on the sale of a product in the future is not considered a true debt for COD income purposes.

Debt That Is Equity

Another case where no income should be reported is when a person satisfies debt for less than the face value of the debt that was underlying an equity interest.

The debtholder’s debt may be considered as truly an equity interest for tax purposes thereby resulting in no COD income tax to be reported.

Statutory Exclusions

Let’s look at some exceptions to the discharge of indebtedness outlined in Section 108 IRS.


One exception is that if a person’s debt is discharged in the context of a bankruptcy governed by the Bankruptcy Code will be excluded.

The debt discharge must be granted by the court or further to a plan that was submitted by the bankrupt and creditors approved by the court.


If the discharge of debt that would have been considered as a reportable income occurs in the context of insolvency, the exclusion under IRC 108 will apply.

Qualified Farm Indebtedness

If the debt being discharged is qualified as farm indebtedness, then the COD exception can apply.

Qualified Real Property Business Indebtedness

Under IRS 108, a taxpayer can benefit from the exclusion of COID income when discharging a qualified real business indebtedness.

This rule applies to taxpayers other than C Corporations.

Qualified Principal Residence Indebtedness 

There’s another exclusion under IRS Code 108 which is a temporary exclusion applicable to qualified principal residence indebtedness.

IRC 108 Special Rules

Let’s look at a few special rules that apply under IRS Section 108.

Lost Deductions

Lost deduction is a rule that allows a taxpayer to avoid realizing an income to the extent the debt that is discharged would have given rise to a deduction.

Purchase Money Debt Reduction

Another special rule is the purchase money debt reduction where the debt reduction is considered as a price reduction as opposed to a COD income if the purchaser is solvent and it’s done outside of a bankruptcy proceeding.

Student Loans

There’s a special rule that applies to student loans that are discharged.

If the student’s debt is discharged on the basis that the student has met certain provisions under the student loan of fiding a remunerated employment for a certain amount of time and for a certain type of employer, then the discharge will not be a COD income.

Stock For Debt

A corporation that satisfies debt by issuing stock to the lender is considered as having satisfied its debt obligations and will only pay COD income tax if the value of debt discharged is over and above the fair market value of the stocks issued.

Partnership Interest For Debt

If debt is satisfied by a partner transferring capital or profits-interest to credit, then taxpayer is considered as having satisfied its debt.

The taxpayer will pay COD income tax to the extent the fair market value of the partnership interest is below the value of the debt discharged.

Deferral of COD Income When Business Indebtedness Discharged By Reacquisition

This is a new provision allowing a taxpayer to irrevocably defer COD income in the context of the debtor acquiring its own debt for less than the amount owed and avoid taxes so long as the reacquisition takes place in 2009 and 2010.

IRS Sec 108 Takeaways 

So, what is Section 108 IRC?

How does the cancellation of debt work under Section 108 of the Internal Revenue Code?

Typically, when a person’s debt is discharged without payment, the amount of debt discharged without payment will be considered as a cancellation of indebtedness income (COD income).

The debtor will need to report the COD income and pay taxes on the realized income.

However, IRC 108 outlines different exclusions from gross income by stating that gross income does not include any amount which would be includible in gross income by reason of the discharge.

For example, if the discharge occurs in a Title 11 case, when the taxpayer is insolvent, if the debt qualifies farm indebtedness, qualified real property business indebtedness, and qualified principal residence indebtedness will not result in a COD income.

The IRS Section 108 is a complex provision and you may need to retain the services of a tax attorney or qualified tax expert to be able to understand how it may apply to you.

This article is intended to give you a general idea just so you can get an overall perspective.

I hope that I was able to explain to you what IRC 108 entails and how income from the discharge of indebtedness works.

Let’s look at a summary of our findings.

Understanding IRC 108 (Overview)

  • 26 U.S. Code § 108 refers to Section 108 of the Internal Revenue Code titled Income from discharge of indebtedness
  • The general rule is that if debt is discharged by a creditor without payment or with payment below the amount owed, the portion of the debt discharged without payment will be considered an income from the discharge of indebtedness (or cancellation of debt income)
  • IRS Sec 108 provides certain rules where gross income will not include certain types of debt discharge that would have ordinarily resulted in a cancellation of debt income 
Basis reduction
Business credit
Cancellation of debt
Capital loss carryovers
Credit carryovers
Debt forgiveness 
Debt instrument 
Foreign tax credit carryovers
Issue price 
Loan modification
Minimum tax credit
Net operating loss
Passive activity loss
Pass-through entities
Recourse debt 
Revocation of consent
Surrender of property 
Voluntary conveyance 
What is insolvency
IRC 1001
IRC 1017
IRC 1202
IRC 162
IRC 168
IRC 199a
IRC 2018
IRC 263
IRC 267
IRC 351
IRC 368
IRC 61
IRC 61
IRC 965

Editorial Staffhttps://lawyer.zone
Hello Nation! I'm a lawyer and passionate about law. I've practiced law in a boutique law firm, worked in a multi-national organization and as in-house counsel. I've been around the block! On this blog, I provide you with golden nuggets of information about lawyers, attorneys, the law and legal theories. Enjoy!


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