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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3987
Experience:  Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
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I purchased interest in the LLC in 2010 that owned and operated

Resolved Question:

I purchased interest in the LLC in 2010 that owned and operated a small business. The LLC and its previous owners took a real estate loan in 2001 that matured last year, the bank agreed to an reduced payoff so I am able to obtain new financing to payoff their loan. The LLC is elected to be taxed as an S-Corp. How does that debt cancellation affect me? Its showing as LLC income on the 2012 tax return. How long do I have to pay that taxation if I am liable for it?
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

Lane :

Hi,

Lane :

As an S-Corp Shareholder, you may have some relief under Sec. 108(a)(1)(D


 

Lane :

This deals with what's called "Qualified real property business debt"

Lane :
In this case, If the taxpayer is not a C-corpand is not in bankruptcy or insolvent, the qualified real property (QRP) business debt exclusion might apply
Lane :

THE criteria is the following:




  • Incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property; and

  • Incurred or assumed before Jan. 1, 1993, or if on or after that date, is qualified acquisition indebtedness, which is incurred or assumed to acquire, construct, reconstruct, or substantially improve the property.

Lane :

The amount of income that can be exluded is generally, the following:

Lane :


  • Fair market value (FMV) limitation: The excess of the principal amount of the outstanding debt over the FMV of the real property securing the debt; or

  • Overall limitation: The aggregate adjusted bases of all depreciable real property held by the taxpayer immediately before the discharge (other than property acquired in contemplation of discharge). When applying the overall limitation, the adjusted bases of the taxpayer’s depreciable real property must be determined after reductions in basis with respect to insolvency, bankruptcy, or discharge of qualified farm debt.

Lane :

YOu need to speak with you tax person, this is complicated, but from what you've provided it looks like 183 may apply

Lane :

To exclude COD income from the discharge of QRP business debt, the taxpayer must make a timely filed election (including extensions) on a completed Form 982 for the tax year in which the discharge occurs. The amount of income excluded by a discharge of QRP business debt reduces the basis of the taxpayer’s depreciable real property as determined under Sec. 1017. The basis reduction is deemed to occur at the beginning of the tax year following the year of discharge.

Lane :

This is not NEARLY as simple as the couple of entries on a 982 for a residence forgiveness HOWEVER, if this was secured by the real estate and this is an LLC, taxed as an S-Corp it sounds like it WILL apply

Lane :

THe calculation involve the reduction of what we call tax attributes .. items such as Net operating loss ( For S corporations, the NOL amount is the aggregate amount of the shareholders’ losses or deductions disallowed for the year of the discharge under Sec. 1366(d)(1), including disallowed losses or deductions of shareholders that transferred all of their stock in the S corporation during the year of the discharge)

Lane :

Capital loss carryovers and others, such as passive activity losses and credits.

Lane :

To try to calculate this in this venue is neither efficient nor (for you OR me) nor appropriate ... IF the potential tax savings are significant, you need to sit down with a good CPA... but it sound like this DOES apply here

Lane :

I CAN tell you this: For both entity types (partnerships - or LLCs taxed as partnerships AND S-Corps) , the NOL, capital loss, basis, and passive activity loss attributes are reduced dollar for dollar. The reduction for the other credit attributes is reduced by 33 1⁄3 cents per dollar. ... so, again this is very specific to your situation.

Customer:

There was no bankuptcy involved. The original loan was taken out in 2001 and signed by previous LLC members So the debt was in name of LLC which I purchased interest in 2010. The property appraisal came out higher than original debt balance, that is how the new lender was able to do the new loan....Does Bullet 1 apply to this?

Lane :

Full circle to you questions? Yes, you are liable (the the extent of your distributive share on the K-1) THis election, a debe dischagre, uner section 108, would be woprth investigation with a competent CPA or tax attorney (in conjunction with someone woth a historical yax knowledge - your tax person?) of your company

Lane :

THat has NOTHING to do with bankruptcy - I understand - What this turns on is the fact that the debt that's forgiven here is secured by real estae ... YES bullet 1 IS the link her I believe

Customer:

Where can I refer my CPA to for this clarification?

Lane :

Start the conversation with "I believe that the tax on this forgiven debt under section 108, specifically, Sec. 108(a)(1)(D): Qualified Real Property Business Debt

Lane :

There have been several good articles, and let me see if I can find the tax citation itself for you

Lane :

Here's the citation to the code (Internal Revenue Code - Title 26 of US code)

Lane :

(a) Exclusion from gross income.--




(1) In general.--Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if-- ...
(D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness


26 U.S.C.A. § 108 (West)



 




Lane :

Here's the whole pertinent section, but it's sub-part(D) that, I believe, applies here:

Lane :




(a) Exclusion from gross income.--




(1) In general.--Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if--




(A) the discharge occurs in a title 11 case,





(B) the discharge occurs when the taxpayer is insolvent,





(C) the indebtedness discharged is qualified farm indebtedness,





(D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or





(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2014.







26 U.S.C.A. § 108 (West)



Customer:

This language is not in my understanding, to technical for me.

Customer:

I will refer my CPA to these codes

Lane :

Basically ( and your CPA will get this) your LLC-SCorp (would also apply to partnerships) gets to exclude from income (therefore not taxable) the forgiven(in your case debt was renegotiated, but IRS says that's forgiven debt) debt from income

Lane :

your situation falls under section (d) you are not a C-Corp AND the debt ws secured by real estate AND owned by the business

Lane :

THis article covers ALL of the sections - just tell him/her to go down to the section that says:


Sec. 108(a)(1)(D): Qualified Real Property Business Debt

Lane :

This applies to all debt forgiven before year-end 2014

Lane :

Hope this helps

Customer:

Ok......I believe that answers the question for now. Can I come back to you for further help on this question?

Lane :

If this HAS helped, I would appreciate a feedback rating of 3 (OK) or better … That's the only way they will pay us here.


HOWEVER, if you need more on this, PLEASE COME BACK here, so you won't be charged for another question.

Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3987
Experience: Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
Lane and 7 other Tax Specialists are ready to help you
Expert:  Lane replied 1 year ago.

Thank you Sukhjit.

And yes, if I can help again, just say "FOR LANE ONLY," at the beginning of your next question.

But as I said before, if you need clarification on this, specifically, come back here, so you won't be charged for another question.

Good luck with it!

Lane

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