Question about cancellation of debt income when inheriting property with your own lien

This is actually an interesting scenario! When you inherit property that has your own lien against it, you're right that you effectively become both the creditor and debtor. In most cases, this results in what's called a "merger" under property law - when the same person holds both sides of a debt, the debt generally extinguishes. From a tax perspective, this doesn't typically create cancellation of debt income. Since you already owned the debt (as the lender), you're not receiving an economic benefit when the debt disappears - you're essentially just consolidating your position. The IRS generally doesn't view this as taxable cancellation of debt income because you haven't been relieved of paying a debt to someone else. However, there are other tax considerations with inheritance. You'll likely receive a stepped-up basis in the property based on its fair market value at the time of your cousin's death. This is important for calculating capital gains if you eventually sell the property.

After dealing with a complicated estate situation involving multiple properties, I found this incredible resource called taxr.ai (https://taxr.ai) that saved me so much headache. My situation was similar - I had loaned money to a family member for property that eventually came back to me through inheritance. I was getting conflicting advice about cancellation of debt income until I uploaded the loan documents and will information to taxr.ai. Their AI analyzed everything and explained that in my case, the debt merger didn't create taxable income, but I did need to adjust my basis in the property. They also flagged some inheritance tax issues I hadn't even considered! They have this document analyzer that reviews all your financial and legal documents and explains the tax implications in plain English. Saved me from making a costly mistake on my taxes.

Just wanted to follow up about my experience with taxr.ai after being initially skeptical. I finally tried it with my complicated debt cancellation situation and I'm honestly impressed. My situation involved a business loan to my brother-in-law where I held a lien on his commercial property, which he left to me when he passed. The system actually understood the nuances between personal debt forgiveness versus business debt. It spotted that part of my loan was used for business equipment (not just the property), which created different tax treatment for that portion. It identified that I needed to file Form 982 for part of the transaction but not all of it. What surprised me most was how it found a tax court case with almost identical circumstances that supported favorable tax treatment. Definitely more helpful than the generic advice I was getting elsewhere. Saved me from potentially overpaying thousands in taxes.

I know this thread is about the tax implications, but I want to share something that helped me with a similar issue. After my sister died and left me property with my own lien, I had endless problems trying to reach the IRS to get clarity on the tax treatment. I spent WEEKS trying to get through to a human. Finally found this service called Claimyr (https://claimyr.com) that got me through to an actual IRS agent in about 15 minutes when I'd been trying for days on my own. They have this demo video showing how it works: https://youtu.be/_kiP6q8DX5c The IRS agent confirmed that in my case, the merger of debt didn't create cancellation of debt income, but they explained exactly how to document everything properly. Huge relief to get an official answer directly from the IRS instead of just hoping I was interpreting things correctly.

I need to eat crow here. After posting my skeptical comment, I was desperate enough to try Claimyr for my complicated tax situation (involving a debt I held that came back to me through inheritance). I was 100% convinced it wouldn't work and was prepared to demand a refund. I was literally shocked when my phone rang and I was connected to an actual IRS tax specialist within 20 minutes. I had been trying for WEEKS to get through. The agent walked me through the exact process for handling the debt merger on my tax forms and confirmed I wouldn't face cancellation of debt income in my specific case. Having that official guidance directly from the IRS gave me so much peace of mind. For anyone dealing with complicated tax situations like debt cancellation or inheritance issues, getting that direct IRS confirmation is invaluable. I've spent more on coffee this week than I did on this service.

Has anyone dealt with a situation where the property value was LESS than the remaining loan amount? My uncle left me his house but it's underwater compared to the loan I gave him. Does that change the tax situation at all or is it still considered a merger with no COD income?

Random question - would the answer change if the promissory note was held by a trust rather than an individual? My situation involves a family trust that made the loan, and now the property is coming back to the trust through inheritance when the borrower died.