Two people on loan and one pays off debt

Imagine these facts: Adam and Beth are not married. They co-sign on a mortgage. Later, Adam pays the $2 million mortgage in full.

Question: Does Beth owe income taxes for forgiveness of the debt? Is there such a thing as a "gift of debt" in this circumstance?

Quick Answer: The tax consequences depend upon the relationship between Adam and Beth. If they are relatives there is a good chance it may be a gift. However, in the normal course, since they are both liable on the mortgage debt, Beth winds up owing Adam $1 million. Even if they are not relatives but, say, business partners (or an unmarried couple), then there could be a discharge of indebtedness if Adam let Beth off the hook.

The practical solution may be to have Beth give Adam a note (bearing AFR interest) for the $1 million. Then the issue becomes what is the best way to deal with the note. The solution perhaps involves having Beth quitclaim her interest in favor of Adam which itself could cause gain recognition to Beth if the property is appreciated in his hands.

Warning: This is an area in which you need to see an attorney and/or CPA. This posting is not legal advice, and the answer to your particular problem depends on your particular facts.