What happens when a debt is discharged at less than initially contracted?

When a debt is discharged for less than the amount originally owed, it can result in the cancellation of that debt being treated as taxable income for the borrower. This is due to the cancellation of debt (COD) income rules established by the IRS. Essentially, when a lender forgives a portion of what you owe, it effectively enriches the taxpayer to the extent of the amount forgiven. Therefore, the taxpayer may need to report this amount as income on their tax return, unless exceptions apply, such as insolvency or certain types of debt related to a primary residence. This understanding is critical for accurately assessing tax liability if a debt is discharged.