Repssessed rental prop

[John3cpa]

Taxpayer sold his interest in trailer park lot rentals in 2008 at a loss of prox 39,000 on installment sale. No payments ever made. Repossed it in 2010 with a fair value of about 44,000 plus legal fees and past due utility bills of about 5,800. Does the previoulsy claimed loss of 39,000 reduce his basis or is there something more ominous to consider?

[appelman]

Assuming the 39K loss was recognized in 2008

I think it will have to be treated as payment received in the repossession (less the 5.8K of expenses) and reported as Sec 1231 gain taxable as ordinary income to the extent of the loss recognized in 2008. Otherwise, you would have a mechanism for converting your basis into a taxable loss, while retaining the property! (I'd like to see other comments on this.)

[taxxcpa]

Pub 537

Publication 537 illustrates the calculation of taxable gain (if any) and basis of repossessed property. Or at least it did the last time I had to deal with such a situation.

[appelman]

Unfortunately...

Pub. 537 doesn't seem to address explicitly the case of a repossession after a loss has been recognized.

[Lion]

Gain

If you have a colleague at HRB, borrow his textbook on Repossessions, Foreclosures, & Cancellation of Debt. It has a great worksheet Statement of Repossession for Seller to compute gain and basis. One note from the text: If a loss was realized on the original sale, recognzed gain on repossession will be zero.

[John3cpa]

Simply put

So my gain to report now is the difference between the original loss reported of 39k and the loss as if my sales price had been the current land value received 43k less the expenses of foreclosure (6K). That reclaculted loss is 22k instead of 39k, so my gain now is the differnce or 17k??

[John3cpa]

Really confused

Lion,
Recognized gain ZERO? That does not seem right to me. The payment actually being received (value of the foreclosed land) is greater than the original sales price reported in theyear of the installment sale.

[Lion]

Don't Know!

It's a very old textbook. And, I'm late to be at a client's biz site in another town. It's been years since I took the course and never since I had a real client with your situation. You really have to find an current book (course/expert/whatever) on repossessions and read it cover to cover. CCH has a huge library. Often you can review a book free for 30 days.

[Davc]

Does the previoulsy claimed loss of 39,000 reduce his basis

Yes. And when real property is repo'd FMV is irrelevant.

[Gary2]

The rules for repossessing real property are very different from the rules for repossessing personal property. The personal property rules are intuitive. The real property rules are not. I'm assuming that "interest in trailer park rentals" refers to an ownership interest in real estate (as opposed to ownership interest in an S-Corp or other entity).

Look at it this way:

Suppose the original basis was $59,000 and it was sold for $20,000, giving a $39K loss. That loss was recognized in 2008 upon the sale, leaving the seller with a note purportedly worth $50K.

In 2010, the act of repossession effectively traded the note with a face value of $20K for a piece of property. The basis in the property is $20K (the note that was given up), plus any costs of repossession. The fact that the property is worth more now doesn't matter, because you won't recognize that gain until you sell it (with associated selling costs, etc.).

If that still doesn't seem fair, consider that you also lose the ability to take any bad debt deduction for the note (but make sure the 1099-A and possibly 1099-C are properly issued). Plus, since the new basis is less than the FMV, the IRS will get their cut anyway when it's finally sold.

Important: Pub. 537 has a set of conditions for applying the real property rules. If you meet those conditions, you must use those rules. If not, then the personal property rules apply. So double check these.

FWIW, the 2011 HRB book has the same remark as quoted by Lion, but my reading is that the conclusion only applies if the real property rules apply.

Finally, the obvious question is whether this is a real transaction. It seems unusual to me that someone would sell this property without any sort of down payment.

[appelman]

Sounds convincing, but...

I would be more comfortable seeing chapter and verse that explicitly talked about sale at a loss. Also, you lost me in this bit:

Suppose the original basis was $59,000 and it was sold for $20,000, giving a $39K loss.That loss was recognized in 2008 upon the sale, leaving the seller with a note purportedly worth $50K.

Where does the 50K come from?

I'm still disturbed at the idea of converting basis into a current tax deduction while retaining the property. It seems sort of like a wash sale!

The worksheet in Pub.537 talks of "payments received or treated as received." What I wonder is whether the 39K should be treated as a payment received. Also, consider this paragraph from Pub. 537:

"The rules for the repossession of real property allow you to keep essentially the same adjusted basis in the repossessed property you had before the original sale. You can recover this entire adjusted basis when you resell the property. This, in effect, cancels out the tax treatment that applied to you on the original sale and puts you in the same tax position you were in before that sale."

[Gary2]

Where does the 50K come from?

It comes from my brain and eyes being fried. It should be $20K.

I'm still disturbed at the idea of converting basis into a current tax deduction while retaining the property. It seems sort of like a wash sale!

Yep. That's why I said it's counter-intuitive. Except that it's not a current tax deduction, it's a deduction in 2008 and an acquisition in 2010.

The worksheet in Pub.537 talks of "payments received or treated as received." What I wonder is whether the 39K should be treated as a payment received. Also, consider this paragraph from Pub. 537:

Nope. No payments were received.

"The rules for the repossession of real property allow you to keep essentially the same adjusted basis in the repossessed property you had before the original sale. You can recover this entire adjusted basis when you resell the property. This, in effect, cancels out the tax treatment that applied to you on the original sale and puts you in the same tax position you were in before that sale."

The wording here is misleading. If you look at the example, selling a tract of land for $25,000 with a basis of $19,000 plus selling expenses of $1000, when they calculate the basis in the repossessed property, the new basis is only $16,000. This person doesn't recover the entire adjusted basis. If you look at the math, they got the property back, they got $9000 in payments, $500 expense of repossession, netting them $8500 in payments, but only paying tax on $4500 ($1800 from prior year payments and $2700 taxable gain on repossession). They have received $4000 in cash, tax free, but it's offset by reducing their basis from the original $20K ($19K plus $1k selling) to $16K.

[appelman]

Counter-intuitive is, indeed the word.

But I think I'm convinced.