Reposession of Corp Assets w/ Shareholder Guarantee

[JoshinNC]

My clients (husband and wife) own 50/50 interests in an S-Corp. The S-Corp had a fully depreciated truck with a note remaining on it of let's say $10,000. The S-Corp stopped making payments on the note and voluntarily returned the vehicle to the lender. Usually I would say that the truck was sold for $10,000 (cancelled debt left owing) and that gain would pass through to the shareholders.

But, the shareholders had a personal guarantee on the note, so when the truck was returned to the lender the lender then went after the shareholders for the $10,000. Ultimately the shareholders filed bankruptcy and the $10,000 was discharged. I know the $10,000 will not be personal cancelled debt income due to the bankruptcy.

My question is this, is the volunary repo of the truck at the Corporate level still a sale for the debt cancelled to the Corp in the repo? I am thinking yes, but for some reason my brain keeps going back to the personal guarantee as maybe cancelling out that deemed sale on the repo.

[Gary2]

I don't think you can mix up the sale (presumably a capital asset, though subject to recapture) with the cancellation of debt income.

The S-Corp has a sale based on the FMV of the truck - perhaps negligible. It's not based on the amount of debt canceled, since presumably it's recourse debt with respect to the S-Corp. The canceled debt income is reported separately by the S-Corp (not necessarily in the same year as the imputed sale).

I'm afraid I can't help beyond that. In particular, it's not clear to me whether the personal bankruptcy applies to the S-Corp's canceled debt. It might have to be excluded based on the S-Corp's insolvency; I really don't know.

[JoshinNC]

The S-Corp wasn't insolvent

It was really a "strategic default". The shareholders have now collapsed the Corp and I am preparing the final 2011 return. Since the 1099 for cancelled debt to the S-Corp might not be issued until early 2012 do I just file assuming no cancelled debt income at the Corp level and then amend if the Corp recieves a 1099?

[Gary2]

The debt probably wasn't canceled until the bankruptcy proceedings discharged it - which may or may not be the same year as the abandonment. But once you know that it was discharged by the bankruptcy, I don't think you need to wait for the 1099-C, which may or may not come. Make sure the clients keep all of the records - for more than the usual three years, in case they need to prove that a late 1099-C was issued for the wrong year.

Usually I'm the side of waiting for the 1099-C, but not in this case since the identifiable event isn't defined by the lender's policies.