Rental Property and 1099-C (Wisdom Needed)

[beck]

Hello Fellow Tax Pros!

I want to make sure my thinking is correct on this situation and any guidance is appreciated. Here goes:

Client purchased duplex as rental property in 2006. Made payments and received rents from 2006 thru 2010. Ran into cash problems and made no payments on mortgage nor took rental payments starting from 2011. Allowed bank to do it's thing and eventually agreed to short sale in 2016.

Client has received 1099-C stating amount of debt discharged, FMV of property and personally liable for repayment of debt. Also, has received 1098 from mortgage company showing large amount of mortgage interest received.

My thinking is Sch E will reflect 1099-C debt discharged as income and mortgage interest received as expense. Of course, this generates a huge amount of income. Also, a Form 4797 which will reflect original basis of property, depreciation taken in previous years, and 1099-C debt discharged as selling price. This will show a loss.

Is my thought process correct?

Thanks in advance for your help

Beck

[Super Mom]

Just off the top of my head, if he was paying no mortgage payment in 2016 the duplex was not "available" to rent, thus no Sced E. The 4797 scenario sounds right. The mortgage interest would only be deductible on Sched A I would think.

See what others have to say!! Good Luck!!

[Roland Slugg]

Some of the facts in the OP are puzzling. If your client stopped making payments in 2011, how could he have received a 1098 form showing a large amount of interest paid by him in 2016? You said the property was the subject of a short sale. Did the lender treat some of the sale proceeds as paying the accumulated interest on its loan?

It was also unclear what you meant by "Sch E will reflect 1099-C debt discharged as income." If there is COD income, it doesn't belong on Schedule E. That will also depend on the FMV of the property and whether or not the debtor was either bankrupt or insolvent at the time of the triggering event.

Basically, report the short sale the same as you would any other sale. The selling price was the amount of debt at the time. It exactly the same as if the owner had sold the duplex on the open market and the proceeds were exactly enough to pay the outstanding loan. Report the transaction on F-4797, starting in Part III if there was a gain, or in Part I if there was a loss.

[beck]

Info

Some of the facts in the OP are puzzling. If your client stopped making payments in 2011, how could he have received a 1098 form showing a large amount of interest paid by him in 2016? You said the property was the subject of a short sale. Did the lender treat some of the sale proceeds as paying the accumulated interest on its loan?

It was also unclear what you meant by "Sch E will reflect 1099-C debt discharged as income." If there is COD income, it doesn't belong on Schedule E. That will also depend on the FMV of the property and whether or not the debtor was either bankrupt or insolvent at the time of the triggering event.

Basically, report the short sale the same as you would any other sale. The selling price was the amount of debt at the time. It exactly the same as if the owner had sold the duplex on the open market and the proceeds were exactly enough to pay the outstanding loan. Report the transaction on F-4797, starting in Part III if there was a gain, or in Part I if there was a loss.

Thanks Roland. I'm as puzzled about the 1098 form as you are. It states mortgage principal beginning balance 438,159 then applied principal 128,797 and ending balance $0. Mortgage interest received of 89,575. 1099-C received shows debt discharged 310,361 and FMV 325,000. I have no other paperwork showing if lender treated proceeds as paying accumulated interest on loan.

Taxpayer was not bankrupt or insolvent at time of event.

For some reason my thinking was confusing 1099-C equaling income to the rental property. Thanks for your assistance

[beck]

Tax Act Posts 1099-C into Schedule E

FYI...1099-C for rental gets diverted into Schedule E as income.

Beck

[beck]

Fyi

Just a little info for my fellow preparers. I found some guidance on the IRS website that publishes audit guidelines for various situations. This is the link regarding "REAL ESTATE PROPERTY FORECLOSURE and CANCELLATION OF DEBT"

https://www.irs.gov/pub/irs-utl/real_estate_foreclosure_atg.pdf

Thanks,
Beck

As if we don't have enough read. ha ha!

[TAXNJ]

Is this what you are saying from the reference source in your post?

IRS Audit guide (third point below)

Taxable cancellation of debt income is reported as:
• Non-business Debt – Form 1040 as other income.
• Sole Proprietorship – Schedule C or F as other income, if the debt is related to a sole
proprietorship nonfarm or farm business.
• Non-Farm Rental Activity – Schedule E as other rental income, if the debt is related to a
nonfarm rental of real property.
• Farm Rental Activity – Form 4835 to report rental income based on crops or livestock
produced by a tenant.

[DonB]

My logic; short sale proceeds used first to pay back interest, next to satisfy mortgage, unsatisfied mortgage is COD.

[beck]

Reply to Tax NJ

When I first posted the 1099-C income being sent to Sch E was after previous poster stated that it wasn't Sch E income. My software asked what the 1099-C was affiliated to and it is the rental property, so it put it into other income on Sch E. Then I found the IRS audit guidelines mentioned above and point 3 in your notes places that income into Sch E.

Hope that is clear as mud. haha

Beck

[TAXNJ]

When I first posted the 1099-C income being sent to Sch E was after previous poster stated that it wasn't Sch E income. My software asked what the 1099-C was affiliated to and it is the rental property, so it put it into other income on Sch E. Then I found the IRS audit guidelines mentioned above and point 3 in your notes places that income into Sch E.

Hope that is clear as mud. haha

Beck

Very good source!! (the IRS Audit guide you referenced - not the software)