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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Rental property foreclosed in 2015. Balance of borrowed

Customer Question

Rental property foreclosed in 2015. Balance of borrowed money note owed is 450k. Total amount owed is 635k (interest and legal fees, understand that does not play into the 1099 for tax purposes). Property placed in service 2007, cpa used 550k as FMV. Have depreciated approx 150k. Paid 615k for property. FMV at time of foreclosure is in question, bank bid 175k at foreclosure auction (and won), turned around and listed for 340k (still not sold).Never stayed a night in the place, rented continuously. Expect that I will receive a 1099-C soon (bank agreed not to pursue deficiency judgment if I would stop fighting foreclosure). Live in a recourse state (FL), not bankrupt, not insolvent.Does section 1231 relieve me from paying taxes on the 1099-C income? thanks.
Submitted: 1 year ago.
Category: Tax
Expert:  emc011075 replied 1 year ago.

Hi. My name is ***** ***** I will be happy to help you.

When a business property is foreclosed and the debt is cancelled, there are couple of things that need to be considered. Cancellation of debt and possible depreciation recapture. If a business property is foreclosed it is treated as disposed/sold. Based on information you provided, if yo sell the property for 340K, you will not have any depreciation recapture to worry about since your basis (purchase price + improvements - depreciation) are higher than the selling price.

For the cancelled debt, if you are disposing the entire property/business you may exclude the loss as qualified real property business indebtedness. You will use form 982 to exclude the debt.

Here are the conditions:

"Qualified real property indebtedness" is, generally, debt that meets all of the following conditions: (i) it was incurred or assumed in connection with real property used in a trade or business; (ii) it is secured by real property; (iii) it was incurred or assumed after 1992, if the debt is either qualified acquisition indebtedness, defined below, or debt incurred to refinance real property business debt incurred or assumed before 1993, but only to the extent that the amount of such debt does not exceed the amount of debt being refinanced; and (iv) you elect to apply these rules by filing Form 982 with your federal income tax return.

"Qualified acquisition indebtedness" is either (i) debt incurred or assumed to acquire, construct reconstruct, or substantially improve real property that is used in a trade or business and secures the debt, or (ii) debt resulting from the refinancing of qualified acquisition indebtedness, to the extent that the amount of the debt does not exceed the amount of the debt being refinanced.

Customer: replied 1 year ago.
does section 1231 take care of the COD 1099 I am expecting to receive?
Expert:  emc011075 replied 1 year ago.

Section 1231 is about business property classification and disposition of business property. It has nothing to do with property financing and cancellation of debt. You will file form 982 - Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) and exclude the debt as qualified real property business indebtedness. You will also have to file form 4797 (Sale of business property).

Expert:  emc011075 replied 1 year ago.

form 982: https://www.irs.gov/pub/irs-pdf/f982.pdf

form 4797: https://www.irs.gov/pub/irs-pdf/f4797.pdf

Sale of business property with cancellation of debt is a complex tax issue and I would strongly advice you to have a professional tax preparer, CPA or Enrolled agent help you with it.

Expert:  emc011075 replied 1 year ago.

The cancelled debt will further reduce your basis in the property so depending on how much of the debt will be cancelled, your losses may be minimal or eliminated altogether.

Expert:  emc011075 replied 1 year ago.

Any questions?

Customer: replied 1 year ago.
no, thanks for your help. I get more confused each time someone gives me advice, but thanks.
Expert:  emc011075 replied 1 year ago.

What are you confused about?

Customer: replied 1 year ago.
my cpa says that I should not use the qualified property exemption, that there have been numerous cases where the court has ruled that unless you are regularly spending your time in real estate matters that they are disallowing it. I spend less than 1 hour a month on this rental (or did). He also says that I have no tax liability due to the COD 1099 because of section 1231. So yes, I am confused.
Expert:  emc011075 replied 1 year ago.

I am not sure how the cpa want's to exclude the debt without 982 exclusion. Section 1231 does't deal with cancellation of debt. 982 exclusions are used to exclude section 1231 property.

Expert:  emc011075 replied 1 year ago.

Well, let me opt out and see if another expert have different advice.

Customer: replied 1 year ago.
I see that the irs has issued a safe harbour rule for real estate professionals in submission of real property exclusions. That further supports what he is saying, I do not qualify as you need to be materially involved in the management of the property. Bot***** *****ne, should I plan on having to pay income tax on the 1099-C? I guess that is all I am looking for. thank you.
Expert:  Lev replied 1 year ago.

Hi different expert here... please allow me to assist.

Based on your information you provided - you do qualify for the "qualified real property indebtedness"

I see no issues as long as that is a rental property.

There is no such requirement to be a real estate professional or to spend any minimum time in the real estate activity.

If you CPA has any court cases which ruled differently - I would be glad to review and verify.

On the other hand - you are NOT required to claim that exemption - and if for some reason you see no benefits - you may simply include COD income into your tax return.

So far - that is your choice.

Customer: replied 1 year ago.
Seeing that it is several hundred thousand dollars of CODI (albiet income tax associated with it), why would I not want to use the exemption? My cpa says i do not need to, per section 1231 he says I do not owe it. Is he correct?
Expert:  Lev replied 1 year ago.

I can not argue with your CPA using you as an intermediary...

I believe that there is a misinterpretation of what your CPA said.

But again - section 1231 has NOTHING to do with COD income - there is no direct connection.

You may report COD income and section 1231 loss at the same time - there is nothing wrong with that choice.

"Do not need" and "can not do that" - these are different statements.

So if you provide references to court cases - I would be glad to examine and provide a feedback.

But without specific arguments I am neither agree nor disagree...

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