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On personal level, what canceled debt means to individual taxes

Donald J. Trump wants the United States to renegotiate its federal debt.

Debt-cancellation_canceled-forgiven-debtErasing debt can help with individuals' cash flow, but it brings new tax considerations.

I'll leave that economic debate to the experts in the dismal science. They already are all over Trump's CNBC interview, where the self-proclaimed "king of debt" addressed the issue of whether the United States should pay its debts in full.

"I would borrow, knowing that if the economy crashed, you could make a deal," the presumptive Republican presidential nominee told the cable financial news network. "And if the economy was good, it was good. So, therefore, you can't lose." 

My immediate thought is that "you can't lose" is a phrase that should make anyone, especially voters, a little leery.

Economic doubters: Similar reaction from the financial world was swift.

Experts described Trump's vague proposal as fanciful, saying there was no reason to think America's creditors would accept anything less than 100 cents on the dollar, regardless of Trump's frequently (self) touted deal-making prowess.

"When it comes to fiscal responsibility, people are always looking for the easiest of answers," Maya MacGuineas, president of the Committee for a Responsible Federal Budget, told the New York Times. "If there were low-hanging fruit here, the Treasury Department would already be on it."

Twitter take-downs: The reaction to The Donald's debt idea was swifter on social media. A "Get Creditors to Accept Less" hashtag is having a field day on Twitter.

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When canceled debt works: Trump's discussion of renegotiated debt on the national level also got me thinking about this financial matter on the personal and, of course, tax level.

Canceled debt is a good idea for many folks who find themselves so far behind on a loan or credit card charges that they will never be able to pay it in full.

In many of these cases, folks just stop paying. That's not a good idea. It wrecks your credit rating and it means that the interest and penalties keep growing exponentially.

Others opt for debt renegotiation. Some creditors will renegotiate the amount owed so that they can clear their books and at least get something.

That's a good deal, too, from the debt standpoint for the owing individual. No more owed amounts hanging over your head. And once the reduced debt is paid, you'll have that money back in your regular cash flow stream.

Individual canceled debt tax costs: But there's also a downside. Debt that's written off in such negotiations is considered, in most cases, as taxable income.

As I noted in a recent discussion with Jill Krasny at Credit.com, it's income because it's money that you didn't have to pay. "It doesn't seem reasonable, but it's the same sort of thing as winning a prize. The value of that prize is taxable."

It is, however, a prize you wish you hadn't won.

This cancellation of debt income, or CODI, mostly shows up when your reconfigure unpaid items such as credit card bills.

Since the housing crash of 2007, however, it's also been an issue for folks facing foreclosure.

When a bank repossesses a piece of real estate, the amount left on the mortgage is, in technical terms, forgiven. But that word is not as liberating as you might think.

The forgiven, or canceled debt, in a foreclosure or even a loan restructuring is, again according to the tax code, taxable income.

CODI exception for some real property loans: Except for folks whose home loans are covered under the Mortgage Forgiveness Debt Relief Act of 2007. Here eligible homeowners can avoid taxes on the portion of a mortgage that is partly or entirely forgiven when the lender restructures the loan or the property goes into foreclosure.

Technically, this tax break is still temporary and since its enactment on Dec. 20, 2007, it has been renewed as part of various extenders bills. The latest lease on tax break life came on Dec. 18, 2015, when the mortgage debt tax break was part of the Protecting Americans from Tax Hikes, or PATH, Act.

Thanks to PATH, the canceled mortgage debt option is in effect through this 2016 tax year.

Will Congress finally decide that the housing market has healed enough so that the tax break can finally expire. That would return treatment of forgiven housing debt back to the same status of other canceled, and fully taxable, canceled debt.

Or will the housing industry and its lobbyists be able to convince the House, Senate and new president to keep the tax break on the books?

Right now arguments could be made for both sides. Check back in December to see what the mood and makeup of Capitol Hill allows.

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