Rental Foreclosure Insolventcy

[Sabre]

New client came in Wed. with a foreclosed rental property and he is insolvent about $300,000.

Basis in rental property after depreciation is $123,500 and there is a passive loss carryforward of $40,000 on this property.
Principal balance on the loan at foreclosure was $324,225 with a property FMV of $202,500. Therefore the debt cancelled is $121,725 ($324,225 less $202,500). Based on reading everything i could get my hands on here is what i plan on doing:


Reporting no cancellation of debt income. Reducing the depreciable basis in the rental real estate by the amount of the debt cancellation to $1,775 ($123,500 less $121,725). Showing the sale as:

Sales Proceeds $202,500
Tax Basis $ 1,775
Gain on sale $200,725

I do have the passive loss to help but it is still a pretty big balance due-

Am i doing anything incorrectly?

I appreciate the intelligence of this community especially since i am a sole proprietor.

[appelman]

See Pub. 4681, p. 9

You reduce your basis on property held at the beginning of the year following the year of debt cancellation. If the property was foreclosed on during the year, he did not hold it at the beginning of the following year, and there is no basis to be reduced. Report the sale using the basis without reduction.

[Sabre]

Rental Foreclosure Insolvency-Appleman Response

Evan thanks for your response - i had read the pub 4681 and looked at the page you referred me to. However on page 10 of the pub in the paragraph right under the heading- Qualified Real Property Business Indebtedness it states:" If you dispose of your depreciable real property before the beginning of 2012, you must reduce its basis (but not below zero) immediately before the disposition"

This would lead me to believe that my proposed treatment is on the right track.

[appelman]

Insolvency exclusion

I assumed from your post that you were claiming the insolvency exclusion, not the QRPBI exclusion. However, even the latter is. in my opinion, somewhat ambiguous. The provision you quote was put in to prevent people from rushing out to dispose of their depreciable assets before year-end in order to avoid having to reduce their bases. I'm not at all sure it applies to property that was no longer in your possession as of the date of debt relief, which usually comes after the actual foreclosure. However, taking the insolvency exclusion avoids the whole issue.

[Sabre]

Rental foreclosure insolvency

Evan,

My client is really insolvent so that is the reason i am not reporting the debt foregiveness as ordinary income but instead reducing his basis in the underlying rental property. Thus i end up with a substantial gain on the transaction.

I could not find a clause that would allow me not to adjust the basis downward in insolvency-if you can point to something specific in the pub or code i think i am stuck with the gain.

Your comments have been appreciated.

[S T]

I can feel your concern on this transaction, as I have a similar one - but my client has NOT received the 1099C - only the 1099A (which seems to have unrealistic $$ amounts) and Client went through Bankruptcy to relieve - and the Trustee took all of the Rent $$ prior to the Lender issuing Abandonment.

I still don't know how to treat this one either.

Hopefully someone will post on some of the Tax Treatments of these unusual situations with Bankruptcy and Insolvency.

Sandy

[appelman]

Bankruptcy and insolvency are the easy ones.

File the 982 and check the boxes. Bankruptcy trumps everything else. The two exclusions are discussed on pp. 4-5 of Pub. 4681. Required reduction of tax attributes for bankruptcy and insolvency are explained in detail on pp. 8-9 of Pub. 4681. The sentence that disposes of Sabre's concern, from the 2011 edition, is:

"Basis. Reduce the bases of the property you hold at the beginning of 2012 in the following order (and, within each category, in proportion to adjusted basis)."

But you do have to decide whether you're claiming the insolvency exclusion or the much more restrictive QRPBI exclusion. The rules are different. I can see no reason for anyone who is well and truly insolvent to claim the QRPBI exclusion instead.

The instructions for Form 982 are also helpful.