Rev. Rul. 67-200

During prior years a taxpayer using the accrual method of accounting deducted on his Federal income tax return interest accrued on his indebtedness. The interest so accrued was not paid. During 1965, the obligation to pay the accrued interest was forgiven resulting in the realization of income by the taxpayer for that year. The taxpayer was solvent both before and after the forgiveness of the interest indebtedness.

Held , in computing gross income of the taxpayer for the taxable year of the forgiveness, the amount of interest forgiven shall first be excluded from gross income to the extent of the recovery exclusion, if any, computed under section 111 of the Internal Revenue Code of 1954 and section 1.111-1 of the Income Tax Regulations. Any part of the interest forgiven which is not excluded from gross income under section 111 of the Code, may be excluded from gross income under section 108 of the Code for the taxable year of forgiveness provided there is filed, in accordance with section 1.108(a)-2 of the regulations, a consent to the adjustment of the basis of the taxpayer's property. The basis of the property shall be reduced in accordance with section 1017 of the Code and section 1.1017-1 of the regulations. However, the amount of the interest forgiven which is excludable under section 108 of the Code cannot exceed the basis of the taxpayer's property which is being adjusted. Thus, any portion of such amount which exceeds the basis is includable in gross income under section 61(a)(12) of the Code.