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X sells an apartment building to Y for $1,000,000. Y pays X $200,000 cash and assumes an outstanding first mortgage of $650,000. Y gives X his personal note (fully recourse) for the $150,000 difference and secures the debt with a second mortgage on the building. Subsequently, a dispute arises between Y and X as to certain representations made by X as to the quality of the wiring in the building. In settlement of that dispute, X cancels $20,000 of Y’s personal obligation to him, thereby reducing Y’s debt to X to $130,000. At the time of the discharge, Y was solvent.

  1. What are the tax consequences of the discharge to X and Y?
  2. The same facts apply as in part a., except that there was no dispute concerning the representations that X made. Instead, X cancelled $20,000 of Y’s debt to X to compensate Y for personal services that Y had performed for X. What are the tax consequences to X and Y?