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R. Klein, EA
R. Klein, EA, Enrolled Agent
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Gain

Customer Question

is the gain from the sale of rental property all capital gain..the property was purchased in 2006 and used the macrs 27.5 year life for five years....there is no recapture of ordinary income is there?.
Submitted: 2 years ago.
Category: Tax
Expert:  R. Klein, EA replied 2 years ago.

Randalltax :

Yes there is recapture when using MACRS, It is a flat 25% tax on that portion of the gain.

Customer :

ugh where does the deprec portion go after Part III of 4797...can you walk me thru the lines of the return I need to go offline until 11pm but will get your response and accept at 11pm....is it 12 50 property or please give me flowthrou to page 1 and or Sched D..thank you.

Expert:  R. Klein, EA replied 2 years ago.

You've got a lot of work if you are trying to do this by hand! I strongly recommend investing the $75 in a tax program!

 

You first have to divide out the sale of the house (with depreciation recapture) from the sale of the land. They are reported separately.

 

THe Land ends up on 4797 Line 2

 

THe House ends up on 4797 Part III which is summarized on Line 30 to 32. Then it flows to Line 6 of the 4797 and finally to Sched D Line 11.

 

 

Customer: replied 2 years ago.

Recap please and for now just exclude the land part) Form 4797 Line 22 has the accum deprec and flows to 25a and 25b, then Form 4797 Line 31, then Page 1 Form 1040 Line 14 as ordinary income and the rest of the gain form 4797 Part 3 Line 32 goes to 4797 Part 1 Line 6, then Sched D Line 11.

 

 

I am not sure how the tax on the ordinary income is suppose to calculate at a flat 25%. I do have a tax program but i need to understand it to be able to check it and sometimes the asset module system does not apply the proper tax treatment.

 

And finally, would the treatment of this sale be any different if it was due to a debt cancellation (Form 1099C received) and a reduction of basis on Form 982, would that change to treating the entire gain to capital. You have been very helpful.

 

I will have to accept this answer this afternoon with bonus for sure.

Expert:  R. Klein, EA replied 2 years ago.

Line 22 - check

Line 25 - nope. Buildings can be S.1231 property not 1245 (and therefore not subject to ordinary gain on recapture)

Then to Lines 30 and 32 (not 31)

Sch D Line 11 - check

 

I guess I need to backtrack and correct myself since this is a residential property and the recapture does not need apply.

 

If this involved a debt cancellation, then you have a whole new ballgame. Assuming the property was sold at a profit, then the calculations we have discussed would be the same. THe 1099C is handled separately.

 

If you included the 1099C in the "gain" of the sale then all of this won't make sense.

 

The 1099C is considered income unless an exception applies. Yes, there could be a reduction of basis on the sale, but only if you are insolvent or in bankruptcy on the date of discharge...lots of things going on.

 

 

Customer: replied 2 years ago.

i am so sorry you are stuck with me but i need to get this resolved. I promise you I will compensate your time because I am going to pass along this answer on my own bill....

 

 

 

ok this is the first answer I received from "Robin"

 

 

However, there are two basic exceptions to this general rule:

(1) When the amount forgiven/deficiency is included in a bankruptcy filing.
(
2) When you are insolvent at the time the debt is forgiven.

One more exception applies if your rental qualifies as Section 1231 property. 1231 property must be used in a trade or business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. . In this case, you may be able to reduce the cost basis of the rental property without being insolvent. The result is that you don't report the income from the debt forgiveness but you have a lower loss on the "sale' of your property. To use this strategy, you must make an election and the debt forgiven must be "qualified acquisition indebtedness," (i.e. debt incurred to acquire, construct or improve a property.)

This may be your best form of action, especially if there's only one mortgage/loan out on the property,

 

STop first response from Robin............

 

Start second answer from Lev

 

That is correct - following you need to report:

Form 982 - www.irs.gov/pub/irs-pdf/f982.pdf

specifically - for rental property - check the box 1(d) - Discharge of qualified real property business indebtedness

, and put the forgiven amount on the line 2 and on line 4.

You should also reduce the basis of your real property by the amount excluded. Part II of form 982 is to reduce tax attributes.

 

Form 4797 - http://www.irs.gov/pub/irs-pdf/f4797.pdf - is to report the disposition of business property - rental property in your situation.

To calculate your gain or loss - you will use an adjusted basis reduced by the amount of debt forgiven.

 

Let me know if you need any help.



You replied

Even though the sale of the rental results in a gain, it appears the tax is substantially reduced whereby the amount of gain reduced by the depreciation amount is taxed at zero percent and the balance of the gain is taxed at 10%....or $ 1450 in tax versus $5K reporting the Form 1099C as other income....and a small form 4797 loss on the sale of the rental....I guess that is why I am questioning it!

You have accepted an Answer!

From LEV

Tuesday, March 20, 2012 8:41 PM EST

You do not report the canceled debt related to real estate rental property as other income.
By filing form 982 - you are excluding that amount from taxable income.
You only need to adjust the basis of the rental property.

 

Stop response from LEV


 

 

The original facts...Form 1099c $ 54K... Form 1099S $ 72K... Basis in the rental (before any adjustments) $ 96 Accum Deprec $ 21.......All I want to do is record the sale...originally this taxpayer was looking at report $ 54 K as Sched E income and a $ 3K rental loss or is it better to reduce basis and report the $ 51 K gain ($ 21 K at ordinary inc rates and $ 29 at cap gain rates....he has about $ 30 other income on Page 1 of the return.

 

So what would you like to backtrack.......based on the above.....

Expert:  R. Klein, EA replied 2 years ago.

OK...I will have an answer for you shortly, but first, is this taxpayer insolvent or bankrupt? Or is the 1099C to be considered taxable income?

 

 

Expert:  R. Klein, EA replied 2 years ago.

Your basic scenario is that the basis has been reduced by the depreciation.

 

So your basis at sale time is 96-21 = 75. You sold for 72, so you have a net loss of about 3K.

 

Assuming the 1099C did not have an exception, you have income (line 21) of 54K. If there was an exception, then that $54K is not income.

 

In either case, it is NOT part of the sale transaction.

 

This sale is reported on Line 2 of 4797, then flows to Line 7, 11, and 17 then right to the 1040.

 

As you can see, totally different than the other scenario.

 

Yes, I checked this in my software, too.

 

 

Customer: replied 2 years ago.

I never said this was a residential property....this is a residential rental property rented since 2006.

 

Therefore all I need an answer to is..... is the taxpayer's rental property eligible for the reduction in basis under the rules of " discharge of qualified business indebtedness (per Lev above, he is.....)

 

If so is the $ 21 of the $ 51 ordinary income due to depreciation taken

 

If the above is allowed then the scenario is........thru the Form 982 election I can decrease my cost of $ 96 by $ 54 (form 1099c i am not reporting as income any longer) = $ 42baisis before depreciation, less accum deprec $ 21, = $ 21adjusted basis, compared to sales price of $ 72 = gain of $ 51.....by doing this, you are turning some of the Form 1099C ordinary income into capital gain income...some of it ...not all of it....

 

Expert:  R. Klein, EA replied 2 years ago.

I didn't ask if it was a residential property.

 

I asked if this taxpayer was insolvent or bankrupt on the date of discharge. Both Robin and Lev told you how to treat a 1099C IF there is an exception to the income rule. I never saw an answer to the insolvency question, sorry.

 

 

 

 

 

Customer: replied 2 years ago.
Please read this answer from the one expert...apparently there are three exceptions.....Quote....Different expert here.Debt forgiveness income is the difference between the loan amount at the time of the foreclosure or short-sale and the market price or sale price. While Congress did provide tax relief for debt forgiveness income related to a principal residence, debt forgiveness income continues to be taxable for rental properties.

However, there are two basic exceptions to this general rule:

(1) When the amount forgiven/deficiency is included in a bankruptcy filing.
(
2) When you are insolvent at the time the debt is forgiven.

One more exception applies if your rental qualifies as Section 1231 property. 1231 property must be used in a trade or business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. . In this case, you may be able to reduce the cost basis of the rental property without being insolvent. The result is that you don't report the income from the debt forgiveness but you have a lower loss on the "sale' of your property. To use this strategy, you must make an election and the debt forgiven must be "qualified acquisition indebtedness," (i.e. debt incurred to acquire, construct or improve a property.)

This may be your best form of action, especially if there's only one mortgage/loan out on the property, Please see below:

Section 1231 Gains and Losses

2011 Instruction 4797

I hope this helps.
End Quote

You replied

Tuesday, March 13, 2012 4:33 PM EST

Are you saying that if I lower my cost basis in the property from $96 K by the amount of the cancelation of debt which is $ 54 and "sell" it changing the $ 2,071 ordinary loss into a $ 51,299 capital gain, I can change the taxed owed from $ 5K to Zero on Schedule D because it is Section 1231 gain on Line 6 of Form 4797 now. And I can do that because it is rental property that has been held since 2006. That gain flows to Sched D Line 11 which is excluded from cap gains tax??? for what reason does it work that way???

I ask very specific questions and my original question outlayed all the figures asking how to report it on the return....addit info is the taxpayer is not in bankruptcy nor is insolvent but has held the prop and reported income most of the years since 2006.

Also won't the IRS be looking for the 1099c i other income, how do theyknow you are leecting this basis reduction and can you use the entire Form 1099c figure...Sorry this is my first 1099 C situation.

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Expert

You have received an Answer!

From Anne

Tuesday, March 13, 2012 9:18 PM EST

That's ok....they're confusing to say the least.

Yes, as long as the forgiveness of debt is for the acquisition of the property (they haven't refinanced ) . If that is the case, then you may lower the cost basis of the property by the 1099C amount (similar to lowering the basis for depreciation) which gives you more of a gain on the sale.

You must identify that you are making the election under Section 1231. Depending on what software you have, you may either include a note on line 21 (where IRS would look for the 1099C amount) stating something similar to 1099C 1231 election and taxable amount $0, or you may have to include a statement to that affect.

I hope this helps


If you have found my answer helpful, please remember to click the green "accept" button as it is the only way we get paid.
Expert:  R. Klein, EA replied 2 years ago.

Was this house foreclosed and the bank sold it for 72K?

 

Or did the taxpayer sell it himself for 72K?

 

There is a big difference if there was a repossession first!

 

Customer: replied 2 years ago.
the bank sold it.........
Expert:  R. Klein, EA replied 2 years ago.

There are yet more questions to figure out the treatment. Was this a loan with recourse or not? (Is the borrower personally liable for the debt)?

 

 

 

Customer: replied 2 years ago.
absolutely he was liable...the loan was in his name, not connected with any other entity but him personally owning a rental property
Expert:  R. Klein, EA replied 2 years ago.

In this situation, the cancellation of debt becomes a wash.

 

In effect, the property was an involuntary sale. The sale price equaled the value of the loan balance in effect. The cancellation of debt is income and reduces the loss back.

 

So what the prior expert said was essentially correct. But so is my information.

 

You have a bigger loss (of $54K), but you also have an offsetting income of $54K (the canceled debt). In the end, in your situation, you have about a $3K loss.

 

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