The characterization of debt as recourse (where the borrower is personally liable for repayment of the loan) or nonrecourse (where the lender’s sole recourse is to its security) can have important income tax consequences.  When nonrecourse debt is forgiven in connection with a sale of property, the amount of the debt is included in the taxpayer’s amount realized and is usually taxed as capital gain.

In contrast, if recourse debt is forgiven for any reason (or if nonrecourse debt is forgiven other than in connection with a sale of property), then the amount of debt forgiven is treated as cancellation-of-indebtedness (COD) income, which is taxed at ordinary income rates.  However, COD income can be excluded under a number of exceptions contained in the Code, which do not apply to gain from the sale of property.