A discounted payoff typically generates cancellation-of-debt (COD) income equal to the forgiven principal. CRE borrowers can sometimes exclude or defer COD income via section 108 elections (insolvency exclusion, qualified real property business indebtedness exclusion), but at the cost of basis reduction. Tax modeling before signing is essential.
What is the §108(a)(1)(D) election?
For qualified real property business indebtedness, a non-C-corporation taxpayer can exclude COD income from gross income by electing to reduce the basis of depreciable real property by the same amount. The exclusion is essentially a deferral, the basis reduction increases future depreciation recapture or gain on sale.
What about insolvency?
Section 108(a)(1)(B) excludes COD income to the extent the taxpayer is insolvent immediately before the discharge. For a partnership, the section 108 insolvency exclusion is applied at the partner level under section 108(d)(6). The partnership does not exclude the cancellation at the entity level. This election also reduces tax attributes (NOLs, basis) by the excluded amount.
Sources
- Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations · Mortgage Bankers Association · 2026-Q1