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Real Property: Cancellation of Debt and
ForeclosureKim Lawson
Senior tax analyst
Small Business/Self-Employed DivisionMay 16, 2012
The information contained in this presentation is current as of the date it was presented. It should not be considered official guidance
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Cancellation of Debt
• Economic benefit • Gross income includes income from
cancellation of debt (COD)
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Exceptions
• Gifts• Deductible debt• Price reduced after purchase
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Recourse Debt
• Debtor personally responsible to repay the loan• COD income =
Debt Balance Less: Fair Market Value
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Nonrecourse Debt
• Debtor NOT personally responsible to repay loan– Loan secured only by the property
• Generally no COD income
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Form 1099-C
• Issued by lender• $600 or more of COD• Debt discharged in Box 2
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Exclusions under IRC 108
• Bankruptcy• Insolvency• Qualified Principal Residence Indebtedness
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Bankruptcy Exclusion
• Title 11 Case– Includes Chapters 7, 11, 13
• Discharge granted by the court• Discharge under a plan approved by the court
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Insolvency Exclusion
• Exclusion applies to the extent of insolvency• Insolvency calculation:
Total liabilities before the dischargeLess: FMV of total assets before the discharge= Extent of insolvency
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Insolvency Example
Debt Balance $220,000Less: FMV of Personal Residence (200,000)Equals: Ordinary COD Income 20,000
Total Liabilities $240,000Less: FMV of Assets (235,000) Equals: Extent of Insolvency 5,000
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Qualified Principal Residence Indebtedness Exclusion
• Mortgage Debt Relief Act of 2007• Exclusion related to restructuring and
cancellation of qualified principal residence debt• Tax Years 2007 through 2012
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Qualifications
• Principal residence • Debt must be secured by that residence• Debt used to acquire, construct or substantially
improve
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Limitations
• Qualifying debt up to $2 Million • Qualifying debt up to $1 Million for MFS• Discharge related to:
– Decline in value of the home, or– Decline in homeowner’s financial position
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No Exclusion For
• Second home• Rental or investment property• Business property• Debt NOT used to acquire, construct or
substantially improve the residence• Closing costs rolled into the debt when
refinanced
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Only Part of Loan Qualifies
Canceled debt Less: Non qualified debt= Amount of Exclusion
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Qualified Principal Residence Exclusion Example
Debt Balance $ 850,000Less: FMV (735,000)Canceled Debt 115,000Less: Non-Qualified Debt (110,000)Exclusion 5,000
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Ownership of Home Retained
• Ownership of home retained after cancellation of qualified debt
• Reduce basis of residence by amount excluded – but not below zero
• Enter reduction on Line 10b of Form 982
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Other Exclusions under IRC 108
• Qualified farm indebtedness• Qualified real property business indebtedness
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Reduction of Tax Attributes
1. Net operating losses2. General business credits3. Minimum tax credit4. Capital loss
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Reduction of Tax Attributes
5. Basis in property6. Passive activity loss and credits7. Foreign tax credit
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Form 982
• Report COD exclusion• Report amount excluded• Reduction of Tax Attributes
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Foreclosure Consequences
• Gain or loss from the disposition of the property• Cancellation of debt income (if recourse debt)
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Foreclosure Consequences Nonrecourse Debt
• No COD Income• Gain or loss =
Debt Balance Less: Adjusted Basis
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Foreclosure Example Nonrecourse Debt
Debt balance $180,000Less: Adjusted basis (175,000)Equals: Gain from foreclosure 5,000
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Foreclosure Consequences Recourse Debt
COD Income =Debt balance Less: Fair Market Value
Gain or loss =FMV (limited to debt balance)Less: Adjusted basis
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Foreclosure Example Recourse Debt
Debt balance $180,000Less: FMV of personal residence (170,000)Equals: Ordinary COD income 10,000FMV of personal residence $170,000Less: Adjusted basis (200,000) Equals: Nondeductible loss (30,000)on foreclosure
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Form 1099-A
• Foreclosure or repossession• Debt balance outstanding in Box 2• FMV of property in Box 4
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Personal Residence
• COD income may be excludible– Bankruptcy– Insolvency– Qualified principal residence
• Gain from foreclosure may be excludible– Principal residence
• Loss from foreclosure not deductible
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Rental Property
• COD income may be excludible– Bankruptcy– Insolvency
• Reduction of tax attributes• Gain or loss from foreclosure reported on
Form 4797
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Investment Property
• COD income may be excludible– Bankruptcy– Insolvency
• Reduction of tax attributes• Gain or loss from foreclosure reported on Form
8949 - Schedule D
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Real Estate Tax Center
• Tax Tips• Avoiding Problems • Trends and Statistics • Related Links • Tips on Rental Real Estate Income, Deductions
and Recordkeeping
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Additional Resources
• Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments
• Publication 544, Sales and Other Dispositions of Assets
• Publication 523, Selling Your Home
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Summary
• Cancellation of debt creates income• IRC 108 may allow for the exclusion of COD
income • Tax attributes must be reduced when COD
income is excluded
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Summary (cont.)
• Foreclosure results in a gain or loss as if the property was sold
• Exclusions do not apply to gain from foreclosure
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Summary (cont.)
• Recourse debt:– Cancellation of debt income– Gain or loss from foreclosure
• Nonrecourse debt:– Gain or loss from foreclosure
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Questions?
Click the "Ask a Question" link under the PowerPoint window
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IRS Video Portal Go to: www.irsvideos.gov
and click the All Webinars" tab to view
IRS Webinar Archives.