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PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4472
Experience:  35 years tax experience, including four years at a Big 4 firm.
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This is for PD Tax.... I need your accounting and tax expertise for personal advise. Since the accountant does our books, I was curious. My brother and I have several commercial rental properties with leases. We inherited the properties. The business is a partnership. I understand the rental properties are shown as assets on our books for the business. Do the leases, themselves, show as assets? Just curious.... One of the tenants, who has been our tenant for 10 years, is filing bankruptcy. The 6 months back rent and leasehold is included in the bankruptcy. (I think we should have started the eviction process before this occurred, but the tenant has been our tenant for a long time so we allowed our emotions rule us. Ugh!) How will the changes in the new bankruptcy laws affect us as business owners? Also, I am unclear about some other issues. During the bankruptcy proceedings, the tenant does not have to pay the rent, right? If the tenant decides to assume the lease, will he have to pay the back rent? How does that work? If he abandons the lease, will we be out the rent? Can that be shown as a loss on our taxes? Can we charge a fee to allow the tenant to abandon the lease?  

Submitted: 3 years ago.
Category: Tax
Expert:  PDtax replied 3 years ago.

Hi Diana. Generally, leases for properties you own and lease out are not assets you book. A purchased lease, say if you bought out the remaining three years lease from a third party at a favorable lease rate for $10,000, that $10K is an asset to book. The new law requires that some individual debtors who would have just discharged everything under Chapter 7 may have to enter Chapter 13, if their income is deemed sufficient to be able to do so. This requires some repayment of non-priority debts like rent at pennies on the dollar. $.05 per dollar is the standard I normally use when I write plans. Tenants who file for bankruptcy get a few items of relief. One. the unpaid rent goes in to their non-priority debts, and gets wiped out (Chapter 7) or is partially paid (pennies on the dollar, in Chapters 11 or 13). Chapter 11 is for a business restructuring, which can be expensive, so most businesses avoid this. Chapter 13 is a wage earner's plan, and can be used for unincorporated businesses. The lease and future rent are different stories. Two, post-petition rent, for a tenant who chooses not to leave right away and want court protection, is a higher priority claim and likely will be paid in full under the terms of the old lease. This is not long term, since the debtor will emerge from bankruptcy soon. If this is not going to be paid, the court will allow you to proceed with eviction. Three, rent due after that likely has to be part of a new lease. If this is a profitable location for the tenant, the tenant may wish to remain, but will have to make up the back rent and honor the terms of the lease to do so. Your lease likely has a termination clause for bankruptcy; almost all do. You can invoke your rights under the lease to evict, ask the tenant to leave within the period stated, or other remedies as provided in the lease contract. It is possible the tenant wants to stay, and pay rent going forward. I know, it's awkward, and most landlords don't want to know about the hit they are taking, but a tenant is a tenant. Often, a 'private deal' can be reached with the debtor (through his attorney) and you as landlords for a new lease, perhaps at higher rent. Especially if the old agreement did not produce market rent, and you believe you can get higher rent from a new tenant, the new lease could be written for increases you can support and negotiate. Keep in mind the tenant couldn't pay the old rent, so I would want to know why this happened in the first place, and why there won't be any problems going forward. A new lease will require court approval, especially in Chapters 11/13. Most landlords just ask the court to allow eviction. The court will notify you about the Proof of Claim you will need to submit, along with how and where to appear or send in papers allowing you to move ahead in the process. If you plan to ask the court for permission to evict, you can bet you will hear from the debtor's attorney asking for a deal. If the tenant abandons, you will be out any portion he does not have to pay in a Chapter 11 or 13. Since you are a cash basis landlord, you do not get to deduct the unpaid rent as a special deduction, but you do get the tax benefit. Let's say your normal income from this tenancy is $12,000 per year, with $10,000 in expenses, for $2,000 taxable income. For 2013, you would report less rent received, maybe $2,000 in income, with the same $10,000 in expenses, for an $8,000 loss. You can't charge a special fee to the tenant for bankrupting. Your lease spells out specific rights you have in this event, so a review is vital. If he wants to remain in the property, allow his attorney to make it worth your while. New lease, higher rent, might allow you to recoup some loss and keep a long term tenant. Most landlords just want the bankrupt gone, and petition the court to allow eviction. The court often will allow the debtor to vacate without the need for formal eviction proceedings, but each bankruptcy court and/or judge can have its own ways of doing things. Good luck, and thanks for asking for me. Bankruptcy is one of my favorites, and I have done a number of petitions and written a number of post-petition plans. PDtax

Customer: replied 3 years ago.

Wow, what a mess!


Can I actually writeoff the entire loss this year? I thought the rental income was passive income and I would be limited to $3,000 writeoff per year.

Customer: replied 3 years ago.

I have one more question. The lease as written does not permit the tenant to sublet the property. If the trustee for the bankruptcy has a tenant that will sublet the property, I would not be forced to accept this offer, right?

Expert:  PDtax replied 3 years ago.
Can I actually write off the entire loss this year? I thought the rental income was passive income and I would be limited to $3,000 write off per year.

There are limitations, depending on the business (partnership), whether you are considered real estate professionals, or if you materially participate in management. The partnership characterizes the income or loss from all the properties, and nets out income or loss to you. The $3,000 loss is a capital loss, and not applicable here. The loss on this rental gets similar tax treatment as if you only rented out the place for a few months of a calendar year. You can still deduct the costs of operating for the whole year.

The lease as written does not permit the tenant to sublet the property. If the trustee for the bankruptcy has a tenant that will sublet the property, I would not be forced to accept this offer, right? I do not believe the trustee can force you to accept any rights not in your lease. You should be free to do whatever you want, since your lease contract likely terminates upon bankruptcy of the tenant.
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Customer: replied 3 years ago.
Ok. Thank you so much for your usual thorough response. I appreciate you.
Expert:  PDtax replied 3 years ago.
glad to help, and good luck in bankruptcy court.

Customer: replied 3 years ago.
Thanks. I guess it will be a good learning experience.
Expert:  PDtax replied 3 years ago.
It is, but having someone you don't know tell you you don't get your rent, and/or telling you you may evict your tenant, still stinks.

You likely can pursue your claim without an attorney, but your plans for the property will dictate. Evicting the tenant will likely go easier with an attorney who appears in court and drafts the necessary petition. It's often best to just close the book on the business gone bad, and put in a new tenant.


Customer: replied 3 years ago.
Yes, I agree. However, we need to find the money to prepare the property for another tenant.