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Short sale on rental property - how do I figure adjusted

basis?...
Short sale on rental property - how do I figure adjusted basis?
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10/7/2013
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,682
Experience: Taxes, Immigration, Labor Relations
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Lev :

Hi and welcome to our site!
Was the mortgage outstanding forgiven as part of that sale?

Customer:

The 1099-C is not correct - amt forgiven $171,249; no fmv listed; mortgage owed prior to short sale $360,000 - I looked online - property sold for $250,000.

Customer:

I entered the cod on sch e as income; how do I figure the adjusted basis - deprec allowed was $74,039; do I need to prepare the form 982?

Lev :

Did you receive form 1099C?

Customer:

yes -I just told you - box 2 says $171,249 - nothing else except he is personally liable.

Lev :

No need to report COD on schedule E.
Considering your situation - you do qualify to exclude the canceled debt as "qualified real property business indebtedness" No need to verify insolvency - still you will need the tax attribute reduction - means the basis should be reduced by the amount of debt forgiven.
Use 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 and line 10a. The line 10 is specifically to reduce the basis.
The disposition of the property is reported on 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.

Customer:

My software does that automatically - I was told I had to put the 1099-C amount in as income on schedule e.

Customer:

I had a similar situation in 2011 - did not use the 982 and just entered the 1099-c as income on sch e and did the 4797 for a business loss.

Customer:

Now I think I should have reduced tax attributes in the amount of the cod? Help!

Lev :

If you for any reason do not want to claim an exclusion - that is your choice - to include COD amount as taxable income. But I think you do qualify for the exclusion as "qualified real property business indebtedness".

Customer:

so how do I get the business loss and reduce attributes?

Lev :

If you do claim an exclusion - then - you correct - you would reduce tax attributes in the amount of the cod excluded - that means - you will reduce your basis used on 4797.

Lev :

The sale price to be used on 4797 - the actual sale price for the short sale.

Customer:

I'm not following you - by what do I reduce the basis? by the cod? Please make this simple - do I also use the 982? I'm sorry if I sound dense but I'm just not getting the picture.

Lev :

I will give you example - please stay with me...
What was your basis for that property without depreciation?

Customer:

$484,806

Lev :

Ok. so...
Use 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 and line 10a. - $171,249
The line 10 is specifically to reduce the basis.
On form 4797 - your will report the sale transaction.
Use the actual sale price - you should get form 1099A for that. If not - use $250,000 and attach an explanation to your tax return how that amount was determined.
Your basis is $484,806 - $74,039 - $171,249 = $239,518
So your gain $250,000 - $239,518 = $10,482 - which will be treated as depreciation recapture.
Please be aware that is just an illustration example - please verify your exact amounts.

Customer:

Wow, I think I get it! :) There is no business loss - there is a gain. So why do I need the 982?

Lev :

To exclude $171,249 from taxable income.

Lev :

Otherwise - it will be reported on line 21 form 1040.

Customer:

That doesn't make sense. How does that show up on the 1040?

Lev :

COD income that doesn't qualify for exclusion is reported on form 1040 line 21. To avoid that - the form 982 is used.

Customer:

You never use line 21 for business property - only personal.

Lev :

That is your rental property - correct? Not business property?

Customer:

Not mine - a client's. Rental property is business property.

Lev :

We are talking about different things.
Rental activity is NOT a business activity. However the rental property is a Qualified property for the exclusion.


For Qualified Real Property Business Indebtedness - see page 7 in this publication - http://www.irs.gov/pub/irs-pdf/p4681.pdf


Qualified property. This is any property you use or hold for use in your trade or business or for the production of income, including rental income.
Customer:

Now I'm confused again.

Customer:

Does that mean I have to include it on line 21 and not on the schedule e?

Lev :

But you are correct - if the COD is related to rental of real property - it is not reported on 1040 line 21 - but on Schedule E (Form 1040), line 3.
However - because rental property is a Qualified property - you may exclude it as "discharge of qualified real property business indebtedness"

Customer:

So I still don't understand how it shows up on the 1040.

Lev :

it is not reported on 1040 line 21 - but on Schedule E (Form 1040), line 3.
Sorry for confusion.

Customer:

I am so sorry - I just want to understand the logic of the progression of events on the 1040 and other forms.

Lev :

COD related to a rental property may be excluded as "discharge of qualified real property business indebtedness" - to claim such exclusion - the form 982 is used.
When exclusion is claimed - tax attributed must be reduced - in this case - we reduce the basis of the property.
The adjusted basis is used to calculate gain or loss on disposition reported on 4797.

Customer:

Okay, I give up. I've taken enough of your time. You keep repeating yourself and it doesn't make it any clearer. You went back on including the sch e.

Customer:

Why do I need to exclude anything when I've included it as income?

Lev :

I did not "went back"
You would ONLY include COD into rental income Schedule E line 3 - if that COD doesn't qualify for exclusion.
You are not required to claim an exclusion - but generally taxpayers benefits from that.

Customer:

I didn't pay you for generalities - I want specifics for this client - how does it benefit him?

Customer:

Does this qualify for an exclusion?

Lev :

I want specifics for this client - how does it benefit him?
Exclusion of COD income allows not to include income on Schedule E line 3 - and gross rental income will be less. That is not related to the fact if the property is sold or otherwise disposed as in your situation.
Also when the basis is reduced - it is not reduced below zero.
It is possible that because of reduction of the basis - there would not be difference - but to verify that we need to prepare the tax return and compare.
Does this qualify for an exclusion?
Yes - if that was COR related to mortgage where rental property was used as a collateral.
I provided above a reference to pub 4681 related to Qualified Real Property Business Indebtedness.

Lev :

However - if you are asking about reduction of tax attributed in connection to COD - such reduction would be in effect ONLY if COD is excluded. If COD is not excluded - there is NO reduction.

Customer:

All I wanted to know was how to enter the information into my software. I should have waited until tomorrow and called Lacerte. In the future, you might consider explaining things in simpler terms. Go back and read your answers and see if you think they helped me. Good night, Lev.

Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,682
Experience: Taxes, Immigration, Labor Relations
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