Form 1099-c

[AccTaxMan]

Taxpayer's rental property was foreclosed in 2011. There is a Form 1099-C issued for the cancellation of the mortgage. But no 1099-A has been issued.

Without a Form 1099-A, does the taxpayer still report the foreclosure as like he has sold the property to the lender?

[David1980]

The issuer has the option of issuing just 1099-c if they both receive property and cancel debt instead of doing one of each. Was there an amount in box 7, FMV? If so, then they aren't going to issue a 1099-A. I'd report the sale based on facts regardless of form though, if the taxpayer lost right to property in 2011 I'd report the sale in 2011.

[AccTaxMan]

Thank you David for the reply.

How should the amount of debt cancellation be accounted for in the tax return?

A simplified example (a rental property)

Form 1099-C Box 2 "Amount of debt cancelled" is $100,000
Form 1099-C Box 7 "Fair market value of property" is $80,000
Adjusted basis of property $150,000


We report the $100,000 as income on line 21 Form 1040.

We report the foreclosure on Form 4797 as a sale of the property to the lender. We use the $80,000 as the selling price. With an adjusted basis of $150,000, we have a loss of $70,000.

So the taxpayer ends up having a net income of $30,000 ($100,000 - $70,000).

This does not seem right to me. Now I am wondering if the $100,000 should be reported on line 21. It seems to me reporting both the $100,000 debt cancellation and the $80,000 FMV is redundant.

[appelman]

You're doing it right.

Assuming the borrower is personally liable for the debt. You have two different transactions: the relief of debt is one, and the capital gain/loss on the foreclosure is another. You also want to make sure that the numbers are reasonable. the Issuer of the 1099-C can't always be trusted.

[AccTaxMan]

Assuming the borrower is personally liable for the debt. You have two different transactions: the relief of debt is one, and the capital gain/loss on the foreclosure is another. You also want to make sure that the numbers are reasonable. the Issuer of the 1099-C can't always be trusted.

Hi appleman. thank you for your input.

But do you think reporting both the debt cancellation and the FMV of the property (as the selling price) on the Form 1099-C is redundant?

Referring back to the example in post #3, by reporting both the debt cancellation and the FMV of the property, the taxpayer ends up having a profit of $30,000, which cannot be right. He has just lost a property which he has invested almost $200,000 in it originally due to the foreclosure.

[Gary2]

But do you think reporting both the debt cancellation and the FMV of the property (as the selling price) on the Form 1099-C is redundant?

For the purposes of reporting Cancellation of Debt Income, yes, the FMV is irrelevant. However, for the purpose of reporting the effective sale, it's not. The only reason the FMV box is on the 1099-C is for the convenience of lenders, who are permitted to skip the 1099-A and report the FMV on the 1099-C, provided both the foreclosure and cancellation occur in the same year.

Referring back to the example in post #3, by reporting both the debt cancellation and the FMV of the property, the taxpayer ends up having a profit of $30,000, which cannot be right. He has just lost a property which he has invested almost $200,000 in it originally due to the foreclosure.

He didn't invest $200,000; the bank did.

For the sake of the example, let's use $200,000 as the purchase price. Between the $80K FMV and the $100K canceled debt, this mean the principal balance on the loan, before foreclosure, was $180,000. So the owner has only invested $20K into the property, either as down payment or principal payments on the mortgage. He's also taken $50K in depreciation to get his adjusted basis of $150,000. (Let's ignore whether the numbers are realistic.) So with $20K invested and $50K of depreciation deduction, the $30K of taxable recovery makes perfect sense. Don't call it "profit"; that may be what's confusing you.

If, instead, this was their home, the adjusted basis would have been $200,000. This would result in a $120,000 non-deductible capital loss, and $100K of CODI (before exclusions). Obviously they didn't make $100K on the house. But they did to live in a $200,000 home for only $20K. This seems much less fair - which is why we have ways of excluding this from income.

[Davc]

You have a "sale" for 80K (4797). You have COD of $20K to be reported on Schedule E.

[David1980]

Thank you David for the reply.

How should the amount of debt cancellation be accounted for in the tax return?

A simplified example (a rental property)

Form 1099-C Box 2 "Amount of debt cancelled" is $100,000
Form 1099-C Box 7 "Fair market value of property" is $80,000
Adjusted basis of property $150,000


We report the $100,000 as income on line 21 Form 1040.

We report the foreclosure on Form 4797 as a sale of the property to the lender. We use the $80,000 as the selling price. With an adjusted basis of $150,000, we have a loss of $70,000.

So the taxpayer ends up having a net income of $30,000 ($100,000 - $70,000).

This does not seem right to me. Now I am wondering if the $100,000 should be reported on line 21. It seems to me reporting both the $100,000 debt cancellation and the $80,000 FMV is redundant.

On this, I tend to disagree with many. What should be reported in box 2? Well, let's start out with the case where no 1099-c is issued and there is no cancellation of debt. We'll say the original cost was $150,000 and that the property appreciated in value and is now worth $200,000. The bank forecloses and takes the house. No 1099-C will be issued because there is no cancellation of debt - the house was worth more than the debt.

Moving on, let's now say cost was $150,000, the taxpayer paid interest-only so still owed exactly $150,000, and the house is now worth $80,000. After taking the house how much debt is left? My answer is $70,000. $150,000 minus $80,000 equals $70,000. So the amount of debt on line 2 should be $70,000. Remember, when we assumed the house was worth more than the debt no 1099-C was issued so in that case the debt cancelled was $0 - why would our math differ when we pass the threshold where the house is not worth enough to cover the debt?

The problem I think is it's very easy to assume that box 2 of 1099-C reports the same thing as box 2 of 1099-A. But reviewing the forums, we find that box 2 of 1099-C is "amount of debt discharged" while box 2 of 1099-A is "balance of principal outstanding" - quite the distinction, to me. To further complex things, there's that word "principal" on the 1099-A (which the taxpayer in this case didn't receive anyway so is a moot point) - what of late fees, and accumulated interest? Does that count as debt? But isn't reported on 1099-A?

Ultimately the problem we run into is the 1099-C and 1099-A forms are not very reliable, it's hard to depend on them. Who knows whether the lender really accounted for property received when reporting the cancellation of debt on 1099-C. We don't know if the cancelled debt includes things that would be expenses if paid (accumulated mortgage interest for example). We know that's the information reported to the IRS, so if we report the amount of debt cancelled from forms 1099-C the return shouldn't raise any red flags but is that always the right answer?

Table 1-1 in IRS Publication 4681 covers the math as far as how it works, and the table does not rely upon form 1099-C or form 1099-A, just the facts. Assuming the taxpayer is personally liable and the FMV is smaller than the balance of debt before the foreclosure, the difference between the balance of debt immediately before the transfer of property (reduced by any amount which you remain liable) and the FMV of the property is the cancellation of debt amount. The difference between the amount of the FMV immediately before the transfer and the adjusted basis of the property is the gain or loss.

So let's assume the taxpayer originally paid $150,000 for the home (and there is no depreciation or anything so adjusted basis is the same), the home was worth $80,000 at the time of foreclosure, the outstanding debt is $150,000, and the taxpayer is personally liable. The cancellation of debt is the difference between the outstanding debt and FMV so we report $70,000 of cancellation of debt on Schedule E (this is a rental right?) The sales price will be the smaller of the FMV or outstanding debt, so FMV of $80,000 and the adjusted basis is $150,000 so we report on 4797 the loss of $70,000. The cancellation of debt and loss neatly cancel each other out - but had the taxpayer taken depreciation or something that reduces the adjusted basis you would see a difference, perhaps they had taken $20,000 depreciation so the adjusted basis is $130,000 and now the loss is only $50,000 not $70,000 so the net income resulting from the cancellation of debt is $20,000. ($70,000 COD, $50,000 loss).

That's all assuming there isn't any exclusion for the cancellation of debt we can apply like insolvency.

When I do these, if the cancellation of debt + FMV amount sounds correct for outstanding debt to the taxpayer and the FMV on 1099-C sounds right to the taxpayer, I just go with COD + FMV = balance of debt, FMV = FMV and adjusted basis = just like any other sale of property. If the numbers seem off, I ignore the forms and we get better numbers elsewhere.

[appelman]

Excellent little worksheet

On p. 11 of Pub. 4681. It pretty much takes care of everything.

[Gary2]

On this, I tend to disagree with many.

Generally, when people have the confidence to answer, they agree with you. I certainly do, except for a nit below. It's the people who aren't sure and asking that often make the misinterpretation you point out.

The problem I think is it's very easy to assume that box 2 of 1099-C reports the same thing as box 2 of 1099-A. But reviewing the forums, we find that box 2 of 1099-C is "amount of debt discharged" while box 2 of 1099-A is "balance of principal outstanding" - quite the distinction, to me. To further complex things, there's that word "principal" on the 1099-A (which the taxpayer in this case didn't receive anyway so is a moot point) - what of late fees, and accumulated interest? Does that count as debt? But isn't reported on 1099-A?

Yes, there is a common confusion between the two boxes number 2.

As for the balance of principal, I'm not sure why the IRS wants it reported that way. Note that on the 1099-C, they're not required to report the accumulated interest, but if they do, they must also report it separately in box 3. The distinction is necessary on the 1099-C, because sometimes the interest is deductible (and hence exempt from CODI treatment). On a 1099-A, it's often irrelevant for a recourse loan, since the FMV is typically less (keeping in mind that the purpose of the 1099-A is to report the gain/loss, and the lesser of the FMV or balance is used on a recourse loan). For a non-recourse loan, the balance on the loan is the sale price, but I thought that included the outstanding interest.

Ultimately the problem we run into is the 1099-C and 1099-A forms are not very reliable, it's hard to depend on them. Who knows whether the lender really accounted for property received when reporting the cancellation of debt on 1099-C. We don't know if the cancelled debt includes things that would be expenses if paid (accumulated mortgage interest for example).

I agree that there's a common complaint that lenders make errors on these, and they're more difficult to verify against regular records than a 1099-INT, for example. But the first step for the tax preparer is knowing how to handle them on the assumption that they're correct.

... Assuming the taxpayer is personally liable and the FMV is smaller than the balance of debt before the foreclosure, .... The difference between the amount of "outstanding debt" immediately before the transfer and the adjusted basis of the property is the gain or loss.

This is my nit. If the FMV is smaller than the balance on a recourse loan, then it's the difference between the FMV and the adjusted basis that is the gain or loss.

If the numbers seem off, I ignore the forms and we get better numbers elsewhere.

I've heard of, but never personally seem cases where the numbers are obviously off. It's the cases where they're off a little that the debtor gets taken advantage of.

[David1980]

Generally, when people have the confidence to answer, they agree with you.

I was mostly responding after Davc's post that the cancellation of debt is $20,000. He was assuming box 2 on the 1099-C was the total debt owed before the foreclosure and subtracted out the FMV to arrive at $20,000. When in fact the 1099-C should already have that done and cancellation of debt would be $100,000. I have seen 1099-C where they do report the total debt (incorrectly IMO) instead of subtracting out the value of property received.

This is my nit. If the FMV is smaller than the balance on a recourse loan, then it's the difference between the FMV and the adjusted basis that is the gain or loss.

I blame "fingers faster than brain" syndrome, you're right. When taxpayer is liable the sales price is the smaller of FMV or balance of debt, so when FMV is smaller than debt you use FMV for sales price. I did get it right in the example in the following paragraph at least. Editted the original post in case anyone relies on that later.

[AccTaxMan]

Thank you for all your replies.

After reading through all of them, I know the mistake in my initial thinking now. I thought the amount of debt cancellation income is Box 2 "Amount of debt cancelled. But I think more than one poster have already pointed out that it should instead be the difference between Box 2 "Amount of debt cancelled and Box 7 "Fair market value of property". So the amount of debt cancellation income should be $100,000 (box 2) - $80,000 (box 7) = $20,000 based on the figures in the example.

Just want to make sure one my issue. Does this $20,000 debt cancellation income go to Schedule E or line 21 of Form 1040.
I think someone has pointed out it should go to Schedule E. Does anyone have a different opinion?

[Gary2]

Thank you for all your replies.

After reading through all of them, I know the mistake in my initial thinking now. I thought the amount of debt cancellation income is Box 2 "Amount of debt cancelled. But I think more than one poster have already pointed out that it should instead be the difference between Box 2 "Amount of debt cancelled and Box 7 "Fair market value of property". So the amount of debt cancellation income should be $100,000 (box 2) - $80,000 (box 7) = $20,000 based on the figures in the example.

Just want to make sure one my issue. Does this $20,000 debt cancellation income go to Schedule E or line 21 of Form 1040.
I think someone has pointed out it should go to Schedule E. Does anyone have a different opinion?

No, no.

You had it right the first time, as Evan Appelman said, assuming the 1099-C is correct.

David1980 pointed out, correctly, that the difference between Box 2 on the 1099-A and Box 2 on the 1099-C is a source of confusion. I apologize for nitpicking with him. Though he graciously understood what I was saying, I don't think I help shed light on it.

On the other hand, Davc got it wrong, and David1980 was being gentle by disagreeing instead of just saying that Davc was wrong. So I'll say it.

To reiterate:

On the 1099-A, Box 2 is the principal balance before the foreclosure.

On the 1099-C, Box 2 is the balance after subtracting the proceeds of the foreclosure (roughly).

In other words, if the lender had chosen to issue a 1099-A, then box 2 on the 1099-A would have said $180,000, box 4 on the 1099-A would say $80,000, box 2 on the 1099-C would still say $100,000, and box 7 on the 1099-C (FMV) would be blank. Since the lender chose not to issue the 1099-A, the only thing that changes on the 1099-C is box 7; the other numbers one the 1099-C would be the same whether or not there was a 1099-A.

There are details that complicate this, which is why I said "roughly" above. But let's get the basics straight first. The general rule is that box 2 on the 1099-C is the amount that you report as income from cancellation of debt, unless there's an exclusion on 982, or other complications (such as deductible interest, multiple debtors, or errors in the 1099-C).

To answer your last question, it belongs on Schedule E, but if you just include it as rent, you're bound to get an IRS letter. Another suggestion I've seen is to report it in a different column on the Schedule E, separate from any actual rent or expenses for this property.