LindaB

I have a client who had a cancellation of debt of 105,000. We did the insolvency worksheet and they are definitely insolvent way past the amount of 105,000.

When I do the form 982 I have chosen #5 to reduce the basis of depreciable assets. They have a rental property as well as their personal residence. Which of these two would I reduce and if the rental property do I do it now or at the time they get rid of it? The basis in the rental property is 188,000 and the accumulative depreciation prior to this year was 41,302 leaving an adjusted basis as of December 31, 2008 146,698.

So then on the asset tab would I change the original amount of 188,000 to 83,000. How would any of you handle this? (this is new one to me, so I welcome any comment)

Deb!

Pub. 908 on pages 24 and 25 cover your situation more than anything else I can find. It's the pub. for bankruptcy but this also covers insolvency. You would not be able to reduce the basis of their personal residence because (I assume) you're not depreciating it. Like the other one I mentioned, this also says you reduce the basis at the beginning of the year following the year in which the COD occurs.

This pub. doesn't exactly say how to reduce the basis, but look at the sections in the middle column of page 25, 'Election to reduce basis in depreciable property first' and especially 'Recapture of basis reductions.'

I think it might be better to treat the 105,000 as additional depreciation rather than reduce the original basis by that amount. You said accumulated depreciation at the end of 2008 was 41,302. I think you should continue that depreciation to the end on 2009, lets say that at the end on 2009 accumulated depreciation is 48,000, and adjusted basis at the end of 2009 is then 140,000. If you reduce the original price by the 105,000, that leaves you with an adjusted basis at the beginning of 2010 of 35,000:

188,000 purchase price minus 105,000 to reduce basis equals 83,000 minus accumulated depreciation equals 35,000.

If you treat the 105,000 as depreciation instead, you would end up with the same adjusted basis at the beginning of 2010:

188,000 purchase price minus 48,000 prior depreciation minus 105,000 additional depreciation equals 35,000.

Either of these will satisfy the requirement that "...a reduction of basis will reduce the amount of depreciation or amortization otherwise allowable for the period immediately following the basis reduction," because you would start depreciating 35,000 in 2010 (using the same time remaining I assume).

I think that using the 105,000 as additional depreciation better satisfies the requirements under 'Recapture of basis reductions' on page 25, so I'll leave it to you to read that and see if this makes any sense.

You have to fill out part III of form 8606, you may want to get the instructions for the form to figure out what they want on each line.

There is some information in pub. 334, chapter 5. Regarding reducing the basis of depreciable real property, it says to "Make this reduction at the beginning of your tax year following the tax year in which the cancellation occurs. However,if you dispose of the property before that time, you must reduce its basis immediately before the disposition."

This is for qualified real property business debt, but it's the only thing I have found in answer to your question about when to reduce the basis.

What was the $105,000 COD for? The rental property, credit card debt, or ?

<<Wouldn't you use loan balance of 388K as sales price and his adjusted basis>>

No. It is a recourse loan. The rules are clear that the sales price is the lower of the amount of the loan less the amount still owed by the borrower after the repossession or FMV at time of repossession.

Thanks

Tom

Lodi, CA

What you say here is true IF you are also including and reporting COD income. The lender may be waiting until they actually sell the property to report the COD. It may take them 9 months to sell it, and they may only sell it for $150K, which would increase the COD reported.

(I don't think the rules are clear at all)

Wouldn't you use loan balance of 388K as sales price and his adjusted basis--400K purchase price adjusted for depreciation--for cost?

IRS matches the SSN with the first four letters of the last name.

Tuition and fees worked best. MM

Is it possible the school is going to keep the money to pay for future semesters i.e. fall 2010? Until the parents have the money in hand I think you could go either way. According to pub. 970, "If, after you file your 2009 tax return, you or someone else receives tax-free educational assistance for ... an expense you used to figure a tuition and fees deduction on that return, you may have to repay all or part of the deduction."

If you use the original amount from the 1098-T for the 2009 deduction, then the parents get the refund this year, for their 2010 return you would have to figure the difference between the original deduction, and what it would have been with the additional assistance, and report the difference on line 21, other income. (Pub. 970, p. 53) One problem with this is that they get a bigger refund this year and have it taken away next year. You could avoid that by using the smaller amount, as if they have gotten the money. On the other hand the parents haven't actually gotten the money yet. If they're sure that they will get the refund, I think I would go with the smaller amount for the deduction for 2009.

I have just about decided to use the full amount of the 1098T as a deduction against the 2009 income-the entire amount is not fully deductible-and see what the school issues for the 2010 year.

Are you doing the tuition and fees deduction or one of the credits?

You should try to get a corrected 1099R if this is not really a Roth IRA. If you try to enter it the way it is, you will need to use form 8606, part 3 for Roth distributions, and the return won't be right.

I was just going to tell you the same thing. I looked at the instructions for form 8606, and on page 1 it says that any distribution from a Roth requires a form 8606, part III. Instructions for line 19 say do not include any distributions made on or after age 59 1/2 if you made a contribution (including a conversion) for 2004 or an earlier year. So that tells them that the 5 year holding period is met.

There's a box on the 1099-R input screen that asks for the first year of the Roth contribution but putting 1998 in that box doesn't get rid of the program wanting the 8606. (In the program it says code T means exception applies, but in the IRS instructions for 1099-R it says code T means don't know if the 5 year holding period has been met)

Code T means the payer doesn't know if the 5 year holding period has been met, which in this case it has since contributions were made in 1998 and 1999. I tried this in a dummy return and get the same thing you described. This is not right but I can't see yet where the problem is. It may be a program error. It seems like with the code T they would check the box 'taxable amount not determined' and you could put zero in the 'taxable amount' box and not need the 8606. If you really need the 8606 there must be someplace on it to indicate how long the taxpayer has had the Roth.

Does she get a 1099-INT? If so, could the monthly payments be the life insurance proceeds paid over time instead of in one lump sum when her father died? Then, she'd have earned interest and receive a Form 1099-INT on those earnings but the principal payments wouldn't generate any form, right?

I just got additional information from her, she found the original policy, it was life insurance taken out in 1938. I agree with you that in the case of life insurance paid over time, the amount she receives over the principal amount would be reported as interest income, but she has never received a 1099-INT. Is it possible that in 1986 the rules were different, and life insurance proceeds paid over time were not taxable? Since she has never reported any interest income from this, any suggestions on how I should handle it?

Thanks

Taxpayer has been receiving $100 a month from a life insurance company since 1986 when her father died. There has never been a 1099-R or 1099-Misc issued, and she had never reported any income from this. She doesn't know what these payments are for, just that her father did something because he wanted her to have this money. I assume it was either a commercial annuity or a life insurance policy. I asked her to get more information from the company, they sent a letter with this information (figures rounded off):

Type of Contract--Fixed Amount

First Payment Date--May 6, 1996

Payment Mode--Monthly

Amount of Monthly Payment--$100

Initial Premium--$15,000

Total Paid--$16,400

Current Value as of 12-28-09--$4,600

The original insurance company was Provident Mutual and was bought out or somehow changed to Nationwide in 1996 (payments started in 1986). I called Nationwide and this is all the information they have. They don't have the original contract but might be able to get it. They thought it was probably from a life insurance policy. They never issued a 1099 because the original company never issued one. I assume that when the payments started in 1986 the taxpayer was given information necessary to use the General Rule to figure the taxable part of each payment, but that was never done.

I would greatly appreciate any ideas on what to do with this!

besides the Unified Credit for a person dying in 2009 is $1,455,800 which exempts $3.5 million not $2 mil

And for someone dying in 2010 the estate tax, but not gift tax, is repealed. And also for 2010 the stepped-up basis for inherited property is repealed! They are scheduled to be reinstated after 2010 unless Congress acts.

Thanks KC and Deb. I have sent her the worksheet and instructions how to fill it out. It's a case where I know what to do, but because of the people and their cricumstances, I didn't want to do it.

Thanks, KC. Not a community property state. The mortgage is in both their names so I guess I will give her half of the debt and half the FMV. Has anyone used the Insolvency Worksheet from pub. 4681? I can understand listing as assets cash and bank accounts, stocks and bonds, real estate, cars, etc. But it seems a little daunting to have to list the FMV of all your household goods and furnishings, tools, jewelry, clothing, books,...and other assets not included above.

On a MFJ return, the wife has a 1099-C for canceled credit card debt, it is only in her name. When figuring insolvency, would I only look at her assets and liabilities, or husband and wife combined? I couldn't find an answer to this in pub. 4681.

I think the instructions for line 15 are for when the student is claiming the credit, and the student would have qualified as a dependent on the parents return.

Is that famous "more than half of its own support" still valid for EIC in this case? I know it is for head of household.

It doesn't look like it is for EIC. I thought Eli sounded like he wanted to claim daughter as a dependent also, and he should definitely do the support worksheet first. I'm glad I don't do a lot of these whose kid is it and who gets the EIC returns.

I don't think the daughter can be a qualifying child for mom because with their incomes, how is it possible the daughter does not provide more than half of her own support?

Go back to page 3, Discounts and loan modifications. It must be included. This is not a 'reduction in price' from the seller, as discussed in page 4. Nor is it a gift, nor is it forgiveness of Deductible Debt, it's a forgiveness of Principle.

Under this section on page 3, it says "The amount of the canceled debt must be included in income unless certain exceptions or exclusions apply. For more details, see Exceptions and Exclusions, later." Under Exceptions, on page 4 under Price Reduced After Purchase it describes reducing the basis for the property and not reporting COD income. If Deb determines that this is 'qualified real property business indebtedness' then I think she can use form 982 to exclude this COD income.

Years ago when I worked at Block I had a situation like this. New client came in, they had sold a property about 8 years prior, but never reported the sale. They showed the interest income each year but thought they were recovering their basis for those years, and finally would show the gain, that's why they came in. I ended up amending all prior years, starting with the installment sale. Each year had a small balance due. We put them all in one big envelope, included a letter of explanation, and they sent a check for the total due. I told them to expect a bill from the IRS for interest and maybe penalties. I never heard back from them, but it's possible they could have called Block later and I never heard about it, although I worked off-season so I think I would have heard.

This is from Pub. 908:

Bankruptcy law determines which of the debtor's assets become part of the bankruptcy estate. These assets are treated the same in the estate's hands as they were in the debtor's hands.