12/31/14
Chapter 17 Pages 239-­‐252 General Rules p. 239 1. All income is taxable. 2. Cancelled debt is income. 3. Cancelled debt is taxable: a. To a solvent taxpayer. b. To the extent solvency is restored. Warning! P. 239-­‐240 1.  Form 1099-­‐A is issued by a lender when property is reacquired. At this time debt has not been forgiven. 2.  Form 1099-­‐C is issued by a lender when debt is forgiven. 3.  The forms could be issued in different years! Note: if acquisition and debt forgiveness occur in the same year, only Form 1099-­‐C need be issued. 1
12/31/14
Proposed Withdrawal of 36 Month Rule Form 1099-­‐C Checkpoint 10/15/2014 1.
IRC 6050P imposes a cancelled debt reporting obligation on a creditor when any one of eight identifiable events has occurred. [Judicial proceeding; formal agreement; etc.] 2.
One of those Eight is a 36 month non-­‐payment period. Even though creditor is still pursuing legal action, if within a 36 month period the creditor has not received a payment, Form 1099-­‐C must be issued. In many cases, the Form 1099-­‐C is premature, causing taxpayer a liability without foundation. 3.
4.
IRS proposes to remove the 36 month trigger. Cancelled Debt p. 240-­‐241 1. A cancelled debt represents income. 2. Exceptions: a. Bankruptcy b. To the extent of insolvency. c. Qualified debts: (1) Farm (2) Business real estate (3) Principal residence Cancelled Debt is Taxable if: Net worth + cancelled debt = Positive amount. Cancelled debt is taxable to the extent of the positive amount. 2
12/31/14
Cancelled debt NOT taxable if: Net worth + cancelled debt = a Negative Amount Cancelled debt is NOT taxable; reductions to tax attributes may apply. CancellaOon of Debt p. 242 Net Worth ( $ 8,000) ( 2,000) Positive Cancelled Debt 5,000 5,000 -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ 5,000 -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ Net Gain (loss) ( 3,000) 3,000 5,000 Cancellation of Debt Income for -­‐0-­‐ Line 21, Form 1040 3,000 5,000 Recourse/Non-­‐Recourse p 242 Recourse Non-­‐Recourse If Personal Liability Yes No Then Deemed Sale Price Becomes: Balance of Note Maybe* Yes Property FMV Maybe* No * Lesser of Note Balance or FMV 3
12/31/14
Recourse Debt: Personal Liability p. 242 Sean’s Home Home Basis Facts Tax Effect $ 300,000 Mortgage Balance Deemed Sale Value $ 260,000 Home Fair Value (230,000) (230,000) Debt Discharge income Non-­‐deductible loss $ 30,000 $ 70,000 Non-­‐ Recourse: No Personal Liability p. 242 Home Sean’s Home Basis Facts Tax Effect $ 300,000 Mortgage Balance Deemed Sale Value $ 260,000 Home Fair Value (230,000) Debt Forgiven (260,000) $ -­‐0-­‐ Deemed Adjustment to home value (260,000 – 230,000) Non-­‐deductible loss (30,000) $ (40,000) Bankruptcy Filings EsOmated 2009: 1.5 million Education Level 1991 2001 2007 No college 53.5% 47.9% 41.1% Some college 35.1% 38.6% 43.4% College and more 11.4% 13.5% 15.5% Source: 2007 Consumer Bankruptcy Project Note that better educated people have begun to over extend themselves. Too optimistic? 4
12/31/14
Bankruptcy p. 243 Chapter 7 (no chance to recover-­‐ termination) 1. For individuals or businesses 2. May be voluntary or involuntary 3. Full liquidation of all assets except those exempted by state law 4. Bankruptcy Law of 2005 restricts a bankruptcy filing to those who earn less than state’s median income; otherwise, a “means test”/file Chapter 13 Bankruptcy p.243 Chapter 13 (2nd chance -­‐ Personal) 1. Voluntary basis. 2. Must have stable income so as to repay debt. 3. Can continue to hold assets. 4. A trustee is usually appointed. 5.  Creditors must accept long-­‐term payment plan. 6. Debt must be repaid in 3-­‐5 years. Bankruptcy p. 243 Chapter 11 (2nd chance – Business) 1. May be voluntary or involuntary. 2. Usually no trustee appointed. 3. Purpose is to stay in business with a reorganized business plan. 4. Creditors have a “say” in business operations. 5
12/31/14
General Bankruptcy Provisions p. 243 1. Bankruptcy estate succeeds to the tax loss and deduction carryovers, as well as all debtor tax attributes. 2. IRC 1398 election terminates the pre-­‐bankruptcy short year IRC 1398 ElecOon p.243 Without 1398 Election With 1398 Election 120,000 120,000 Prior Year NOL Not allowed (100,000) Taxable Income 120,000 20,000 Income before bankruptcy filing NOL to Debtor Yes NOL to Estate Yes Maria’s C.O.D p. 244 Net Worth ( $ 8,000) ( 2,000) Any Positive Cancelled Debt 5,000 -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ 5,000 -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ 5,000 -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ Net Gain (loss) ( 3,000) 3,000 5,000 Cancellation of Debt Income for Line 21, Form 1040 -­‐0-­‐ 3,000 5,000 6
12/31/14
George’s Debt p. 244 Property FMV $ 350,000; Insolvent $ 400,000 Rental Property Recourse Non-­‐Recourse Note Balance $ 500,000 $ 500,000 Deemed Sale Price ( 350,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ (500,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ 150,000 ======= $ -­‐0-­‐ ======= Cancelled Debt Deemed Sale Price $ 350,000 $ 500,000 Less property basis (375,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ (375,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ Taxable Business Gain (Loss) $ (25,000) ======= $ 125,000 ======= Cancelled Debt Insolvency Taxable Debt Income (none) 150,000 -­‐0-­‐ (400,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ (400,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ $ (250,000) ======= N/A ====== Tax A]ributes Reduced p. 245 Dollar reduction for tax attributes: 1. NOL [1 for 1] 2. Tax credits [1 for 3] 3. Capital losses [1 for 1] 4. Passive Losses [1 for 1] Tax A]ributes Reduced p. 245 Dollar reduction for tax attributes: 5. Property Basis in this sequence: [1 for 1] a. Business real property. b. Business personal property. c. Other business except inventory, receivables, etc. d. Inventory, receivables, etc. e. Personal property. 6. Passive losses & credits. 7. Foreign tax credits. 7
12/31/14
Depreciable Property Basis Adjustments due to COD p. 246 In this sequence for trade/business/held for investment: 1.  Real property. 2.  Personal property. 3.  Other depreciable. 4.  Real property classified as business inventory. Jon’s Debt p. 247 Original Basis $ 220,000 Retail Building Solvent FMV Building $ 165,000 Loan Value (185,000) Cancelled Debt (20,000) Insolvency: COD Adj. Insolvent $ 20,000 ====== (12,000) Insolvency: Qualified (8,000) Adjusted Basis 200,000 200,000 Election Basis Adjusted $ 180,000 180,000 $ 20,000 $ 10,000 $ 20,000 $ 10,000 Depr. for recapture Cancelled Debt Plus Prior Depreciation Robert’s Debt p. 248 Original Basis $ 500,000/COD $ 80,000 Office Building Acquisition Sale Basis $ 500,000 $450,000 Regular Depreciation (58,228) Adjusted Basis 441,272 Cancelled Debt Basis Adjustment Basis at sale date (80,000) 361,772 (361,771 Gain upon sale $ 88,228 Allocation: IRC 1017 ordinary recapture IRC 1231 capital gain $ 80,000 $ 8,228 8
12/31/14
Home Mortgage Debt Forgiveness p.250 EffecOve 1/1/2007 -­‐ 12/31/2013 !  Limited to $2 million of qualified principal residence debt ($1 million for MFS). !  Qualified debt is: 1. Acquisition/improvement debt residence liens. 2. For principal residence, not 2nd home. 3. Forgiven due to a decline in value; not for any other reason. Principal Residence Debt Laurie: Original Loan $ 800,000 p. 250 Debt House Debt Composition: Balance Initial Debt Credit Card Related Total 740,000 110,000 850,000 “Short sale” Value (735,000) 1,000,000 Cancelled Debt 115,000 Qualified Exclusion (115,000 – 110,000 c/card) ( 5,000) Debt income line 21 110,000 Adjusted Home Basis ( 5,000) 995,000 Qualified Home Debt p. 239 Assets: House FM value $ 1,750,000 Other Assets 42,000 Liabilities: Mortgage (2,500,000) Credit Card Debt ( 18,000) -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ Insolvency $ ( 726,000) 9
12/31/14
Example P. 239 Amount of Loan $ 2,500,000 House “sold” FMV (1,750,000) Debt Forgiven 750,000 C.O.D. Exclusion ($2 M Limit -­‐ $1.75 FMV) ( 250,000) C.O.D. Balance 500,000 Insolvency (726,000) Taxable (Non-­‐taxable) $ (226,000) IRS to Probe Mortgage Debt Forgiveness AccounOng Today 11/15/2010 1.  For 2008: 126,000 to 169,000 filed Form 982 excluding debt of $ 15.2 billion to $ 24.6 billion 2.  61,000 to 93,000 used qualified principal residence debt to exclude $ 6.4 billion to $ 11.8 billion. 3.  These are IRS Estimates since Form 982 allows choices but does not indicate amount of debt amount per “forgiveness” box selected. [Change the Form?] 10