Short Sale COD Income

[Harvey Lucas]

Short Sale COD Income.

Now the complicated ones

My client Mike bought an investment property in 2007. He paid 435,000.
He is not a builder or a contractor, just a guy with a wage job that thought he could make a buck buying improving and selling a piece of property.

Over the next few years he put an additional 350,000 into it as he did a complete remodel and added a second floor.

So his total basis at beginning of 2010 is 435,000 plus 350,000 equals 785,000.

He had hoped to sell it for 900,000 or 1,000,000 as it was prime view property and before the market crashed it was quite likely that he could have.

He tried in vain to sell it but could not.

He filed chapter 13 Bankruptcy in January 2010 and retained ownership of the property until it sold in November 2010.

It was a short sale with the approval of the Bankruptcy Court and the lender.

The balance on the mortgage at time of sale was $640,000, the sale price was 460,000, closing cost’s were 50,000, so the lender got 410,000.

I fill out the worksheet table 1-1, IRS PUB 4681, “Worksheet for Foreclosures and Repossessions”

Part 1
Line I, outstanding debt is 640,000
Line 2, FMV of Prop is 460,000
Line 3, income from COD is 180,000

(The 180,000 COD Income is excluded from income because he is in Bankruptcy?)

Part 2
Line 4, smaller of Line 1 or Line 2 460,000
Line 5, proceeds to seller none
Line 6, add Ln 4 and Ln5 460,000
Line 7, Adjusted basis of prop 605,000
Line 8, Loss from short sale <145,000>

(Line 7, Adjusted basis is original basis of 785,000 reduced by the 180,000 of COD income that was excluded equals 605,000)

I do not report any COD income on 1040 line 21 because it is excluded because of the Bankruptcy.

I report a long term capital loss on Schedule D of <145,000> which will be limited to <3000> per year.

I deduct this <3000> per year for next 5 years while he is in Chapter 13?

If he emerges from Chapter 13, all debts paid, I continue deducting <3000> per year until the <145,000> is all used up.

If the Chapter 13 is converted to a chapter 7 at end of 5 years, and/or he is relieved of any remaining debts, then he loses any future deduction related to the <145,000> capital loss?

However, I continue to be perplexed by the rules of the road regarding COD Income issues and I’m fairly certain that my analysis of this is probably flawed.

I would certainly appreciate any feed back I could get from any of you battle weary tax warriors.

Thank You,
Harvey Lucas

[Davc]

Read the instructions for form 982 line 9. No capital loss.

[Harvey Lucas]

Thanks Davc.

Ok, I looked at the 982 line 9 and read the instructions and I see that I have to reduce any capital loss by any COD Income excluded.

So in that regard, my calculation on the worksheet was a little off, ie, on my original post I had reduced his basis by the COD excluded income.

So if I recalc the woksheet, part 2
Line 4, smaller of line 1 or line 2 $460,000
Line 5, proceeds to seller none
Line 6, add ln 4 and ln 5 460,000
Line 7, Adjusted Basis 785,000
Line 8, Loss from Short Sale <325,000>

So at this point I have to reduce the Capital loss of <325,000> by the COD Income that was excluded, ie, 180,000....so <325,000> reduced by 180,000 leaves an available long term capital loss of <145,000>?

By the way, the COD Income is excludeable for 2 reasons, first he is in chapter 13 bankruptcy (but Im still not sure if Chaper 13 qualifies as a bankruptcy?), and second, even if bankruptcy does not apply he is still insolvent and exlsuion would apply under insolvency.

So I think I have this right now but this whole area of COD income and exclusion is very fuzzy to me because much of the time the results just don't seem logical?

In this example, because it was "an investment property", the loss is limited to <3000> per year....if it were a "rental property" then the loss would be entirely deductible in year 2010 and would create a NOL that could be carried over or carried back...if it were his "main home" then none of the loss would be deductible...

Thoughts?

Harvey Lucas