Debt Cancellation

[Golden Rocket]

Taxpayer is insolvent and we plan to use Form 982 to bail out of a $42,000 Debt Forgiveness.

However, the forgiveness in question was a mortgage on a rental house. Taxpayer was "upside down" on both his personal residence but also on the rental house. Bank received on offer on the house in question, sold it, and wrote off $42K in the process.

Assuming the 982 indicates he is STILL insolvent at time of forgiveness, can he choose to lower his basis on something OTHER than the rental house?? It would appear under the instructions for Form 4797, cancellation of a mortgage would have to be added to the selling price of the home for purposes of calculating gain or loss...

[Koss]

Reduction of Tax Attributes

He may able to reduce certain tax attributes before reducing the basis of depreciable property.

See page 24 of Publication 908.

BMK

[Snaggletooth]

Selecting Attributes

On Form 982 we must select from a list of things by which basis must be reduced. However, Koss' reference to the Pub seems to imply these choices must be chosen in a certain order. Apparently this order can be altered if depreciable property is selected first.

Instructions for the 4797 indicate the debt "payoff" must be added to the proceeds for purposes of gains/losses. With regard to the 4797 instructions:
1) Do these instructions conflict with the 982 instructions, and
2) Is the debt forgiveness interpreted to be the same as a "payoff?"

[Gary2]

Taxpayer is insolvent and we plan to use Form 982 to bail out of a $42,000 Debt Forgiveness.

However, the forgiveness in question was a mortgage on a rental house. Taxpayer was "upside down" on both his personal residence but also on the rental house. Bank received on offer on the house in question, sold it, and wrote off $42K in the process.

Assuming the 982 indicates he is STILL insolvent at time of forgiveness, can he choose to lower his basis on something OTHER than the rental house?? It would appear under the instructions for Form 4797, cancellation of a mortgage would have to be added to the selling price of the home for purposes of calculating gain or loss...

He can't lower his basis on the rental house, since the bank took it at the time of cancellation, so he no longer owns it. The basis adjustment is done at the beginning of the next tax year, not at the time of cancellation.

[veritas]

Your

On Form 982 we must select from a list of things by which basis must be reduced. However, Koss' reference to the Pub seems to imply these choices must be chosen in a certain order. Apparently this order can be altered if depreciable property is selected first.

Instructions for the 4797 indicate the debt "payoff" must be added to the proceeds for purposes of gains/losses. With regard to the 4797 instructions:
1) Do these instructions conflict with the 982 instructions, and
2) Is the debt forgiveness interpreted to be the same as a "payoff?"

client should have received a 1099s. This would include the debt payoff. The debt cancellation is the amount above the debt payoff which the bank wrote off.

[Snaggletooth]

No 1099-S

There was no 1099-S. Indeed, there was a 1099-C, but since there was a sale, this should have been a 1099-A. Those who issue 1099s missed this one from beginning to end...

[Gary2]

There was no 1099-S. Indeed, there was a 1099-C, but since there was a sale, this should have been a 1099-A.

Not necessarily. Lenders are allowed to issue a consolidated 1099-C that contains the 1099-A information in boxes 4, 5, and 7, and not bother with the 1099-A. This can be done if they both apply to the same property in the same year.

[BP.]

There was no 1099-S. Indeed, there was a 1099-C, but since there was a sale, this should have been a 1099-A. Those who issue 1099s missed this one from beginning to end...

Check out Pub 4681 on p. 11 under "1099-C & 1099-A." Lender can combine onto 1099-C.

[Snaggletooth]

Gain or Loss on 4797

WITHOUT having to add back $42K as if it were a payoff, there is a $33K loss. If it has to be added back, there is a 9K gain.

If it is not necessary to add back the $42K, can the client still take a $33K loss? I don't see why not...but then again, what do I know??

[Gary2]

It's entirely possible he has a loss. But are you sure about the insolvency? $42K isn't very much. How far in the hole was he on his residence? Did you factor in retirement assets?

[Snaggletooth]

Factored In

Thanks for the reply Gary. Not only was he upside down on his rental house, he was (and remains) upside down in his residence as well. Even after the cancellation, his liabilities still outstrip his assets by $100K.

Nothing in 401k, IRAs, Roths, etc. Pulled all of this out to mitigate the misery when the housing market crashed a few years ago.

[Gary2]

Sounds like the loss and exclusion are both doable. I suggest taking a look at Dave Fogel's articles. Three in particular, on reducing tax attributes, foreclosure myths, and rental property foreclosures, will be quite helpful.

[Snaggletooth]

Capital Loss

Good and very informative article, Gary.

I think this boils down to the order in which the tax attributes must be reduced. The first available item is a capital loss.

Used in this context, if a "capital loss" includes the loss on Form 4797, the clients loss is absorbed into the COD. Technically, a 4797 loss is an "ordinary" loss as opposed to a capital loss, but I'll almost bet that the the capital loss was intended to include this situation in this circumstance...

[Gary2]

Remember that the attributes don't get reduced until after the tax for the year of cancellation has been calculated.

[Snaggletooth]

Mr. Fogel's Article

One of the attributes reads: "Capital loss of the year of the debt discharge and any carryover to that year". I take that to mean the capital loss must be reduced in the same year of the COD, if one exists for that year.