982 - Reduction of Tax Attributes

[peggysioux]

Taxpayer had a residential rental that was disposed as a short sale and has a loss of $68,000 and a 1099-C of $69,000. Taxpayer is also insolvent at the date of disposition. In filling out the 982, I applied the net capital loss of $68,000 to Part II, line 9 in reducing the tax attributes. My issue is my tax program is still computing a loss of $68,000; I would think being I am reducing the capital loss for the tax year, it would negate my loss on line 14 of the 1040. How do other tax preparers handle?

[Koss]

Form 982

You may have manually reduce the basis of the property.

But be careful, because when you do that, it may cause unintended consequences, like changing the current year depreciation. So you may have to manually override some other values.

You would think that Form 982 would "talk" to other sections of the return. But there are some very complicated rules about the ordering of the reduction in tax attributes, and I don't think the software can do it. The program doesn't know which asset the entry on Form 982 is associated with.

And when you pull one brick out of the wall...

BMK

[peggysioux]

982 - Reduction of Tax Attributes

The property is sold so can't reduce the basis of the property, but the instructions for part II of 982 states that reductions off tax attributes include any net capital loss for the tax year of the discharge. Being my tax software is still showing the capital loss, would you think it a good idea to include an entry on line 21 of 1040 referring to line 9 of form 982 and show the $68,000 as income to negate the net capital loss of $68,000?

[Koss]

Basis

I don't understand why you can't reduce the basis. There should be a way to change the basis in your depreciation screen, or enter an adjustment to the basis on Form 8949. The fact that the property was sold during the current year does not mean that the basis cannot be adjusted.

For example...

Suppose your client sold a rental property in November, 2013. No short sale, no insolvency, just an outright sale. But your client also informs you that in June, 2013, a slice of the land on which the building sits was taken by the government in order to widen the road. He was compensated for that land, and he received a check, several months before he sold the property. I believe that kind of payment would reduce his basis in the property.

This example is transparent, because it is obvious that the reduction in basis occurred before the sale.

But my point is: Why can't you make an adjustment to the basis in the year the property was sold?

In your case, everything is happening at the same time. The reduction in tax attributes occurred when the property was disposed of in a short sale. I believe the reduction in tax attributes caused a reduction in the basis. The change in basis occurred immediately before, or at the same time, that the property was sold. By entering an adjustment, you are not reducing the basis after the disposition; the reduction in basis is part of the whole transaction.

BMK

[AZUKHiker]

If it is a residential rental there is a 1231 loss which is ordinary income, not a capital loss. In addition unless you are electing for the Qualifying Business Real Estate exception for the COD the reduction in attributes due to insolvency is applied to all of the assets that remain after the sale of the rental and which are owned on January 1 of the following tax year.

[peggysioux]

982 - Tax Attribute Reductions

Sorry, mind very tired......you are correct, 1031 loss. So, being taxpayer is insolvent, he doesn't have to pay tax on the cancelled debt and is also able to write off the loss on the short sale? That just doesn't seem correct. Am I missing something?

[AZUKHiker]

Remember whilst the COD may not be taxable now, it may be taxable in the future due to the reduction in tax attributes. For example if they own a vehicle on 1/1/14 with a basis of say $6,000 and assume all of that basis is reduced by the COD tax attribute reduction. There is a good chance that they will sell the vehicle in the future and with no basis have a taxable gain on that disposal effectively taxing some of the COD. Also any tax attribute reduction applied to a main residence will be taxable when that residence is sold. In other words the tax payer will have to track every asset whose basis is reduced by the COD tax attribute reduction.

Also, make sure that all of the COD is covered by the insolvency. Virtually all assets need to be included in the solvency calculation including pension funds.

David Fogel has some excellent articles on COD and property foreclosures/short sales which clear up a lot of the myths in this area.

http://www.fogelcpa.com/Pages/TaxArticles.aspx

[peggysioux]

982 - Tax Attribute Reductions

One would think that the IRS would allow ordinary losses much like capital losses to be applied as a reduction of tax attributes in the year that COD income was non-taxable due to insolvency. The loss basically wipes all taxable income away for this taxpayer. Just doesn't logically make sense to me.

[AZUKHiker]

I think the tax legislation achieves the desired result. There are two completely separate transactions here. 1.The disposal of the property and 2. The COD.

As this is a sale of a business asset then quite rightly there is a deduction for the loss.

On the COD if they qualify for the insolvency exemption then the legislation cuts the taxpayer some slack by not directly taxing the COD by reducing the tax benefit of items such as capital gains or reducing the basis of assets. As the reduction in basis of the assets is treated just like depreciation on a subsequent sale of that asset the COD will likely be eventually taxed but in a future tax year. So the taxpayer gets some relief by delaying the tax due.

Note, if in your case the loss wipes out all the taxable income you might have a NOL and that is one of the first attributes to be reduced by the COD in the ordering rules.

[David1980]

I think it's stupid personally, but agree that is how it works.

Let's take two taxpayers. Taxpayers Arnold and Bob (A and B). Basically these two people are identical in every way except A decides to buy a rental house.

$100k W-2 income. No other income. No assets, they're both terrible at savings, finance, and math. I've got no idea why anyone is paying them $100k - probably the business owner's inept children. Tax after deductions miraculously works out to $20k every year.

In 2010 A buys a rental house for $300k. Has it managed (see bad at math) and someone else collects the rent and pays the bills. To keep things simple, it works out that the rents, expenses exactly offset each other so he doesn't see a dime and the interest-only mortgage payment (also for simplicity).

In 2013 the home value has fallen to $200k and A figures if it has lost value why bother, let the bank have it. 1099-C received for $100k COD and $200k FMV.

A now has $100k of additional COD income but can take an ordinary loss for $100k as well (ignoring depreciation). The loss offsetting the income treats him fairly in my eyes. There's no need to cut this guy any slack because while he has COD income he has an equivalent loss (less depreciation but he got that as an expense anyway in prior year).

But we do cut him some slack. He's insolvent, insolvent for the full $100k. Has no possessions at all, probably because he doesn't know how to save money. So he's able to exclude that full $100k of COD. He still gets the loss though of $100k (less depreciation) which will be enough to offset all of his W-2 income. His tax in 2013 is $0 - yay! And since basis reduction is 1/1/14 and is limited to the value of his depreciable assets it's basically $0.

For 2010, 2011, 2012 A and B both pay $20,000 in tax. A doesn't put any money into the rental or get any money from it. In 2013 A pays $0 and B pays $20,000. Basically we as a country gave a $20,000 credit to A because he bought a house and let it foreclose. And of course had the home gone up in value instead of down he could have sold it for a profit. Win-win scenario for A!

Would it have really been that terrible if A had to pay $20,000 in 2013? It's the same situation he'd have been in had the whole thing never occurred. That's fair in my eyes. Of course, our tax system isn't fair and this is a good example.