In the case of a foreclosed non-recourse loan, what impact does forgiveness of the loan balance have on taxable income?

In the context of a foreclosed non-recourse loan, forgiveness of the loan typically does not have tax implications for the borrower. This situation arises because a non-recourse loan is secured solely by the collateral (in this case, the property) and does not hold the borrower personally liable for any shortfall in case of default. When the loan is forgiven upon foreclosure, the borrower does not recognize any income from the forgiveness since they are absolved from any further personal liability.

This treatment aligns with IRS rules, which state that debt discharge is taxable income unless it falls under certain exceptions, such as being discharged in a bankruptcy or qualified principal residence indebtedness. Non-recourse loans' specific treatment means that the borrower does not have to report the cancellation of the debt as income, protecting them from potential tax liabilities that could arise from forgiven loans in other contexts, such as recourse loans where the borrower remains liable.

Thus, in the scenario of a foreclosed non-recourse loan, the correct answer indicates that the forgiveness does not impact taxable income, as there are no tax implications involved in this specific situation.