Cancelation of debt HELP

[ljwalters]

I have done these before, I don't know why I can't figure it out this time. Maybe I'm already brain dead befor the new tax season even begins. It's been a real trying mentally and physically last 5 months.

So here it goes.

Cancelation of Debt.

Scenario:

Client did short sale on rental house.

Has 1099C for $281,051 including $38,985 accrued interest.

And 1099C for $26,779 including $600 interest.

Insolvency worksheet shows insolvent by $164,236

This work sheet included 401K statement showing a value of $116,283, but the cash out value is half of that only $58,141. The difference is the client does not get the matching amounts until after a certain age.

Questions:

1. To determine insolvency do I use the statement or the cash out amount?

2. Where do I report the interest part of the 1099C? On sch E or form 982?

3. On form 982 part l both b and d apply, do I check both?

4. Does the 1099C amount get added to the sale of the rental house or does it go on 1040 line 21?

5. In this scenario does the insolvent amount go on the 982 part ll line 4?

Final question. What is the advantage of using the insolvency worksheet and form 982 if the amount of insolvency reduces the basis? It seems to cancel out any benefit. What Am I Missing?

Thanks for you help

Linda

[Jack from Ohio]

Insolvency does not apply.

You must calculate a sale of the rental property with whatever basis is there, with the sale price as the amount of debt forgiven. There may be, as is often the case, a taxable capital gain on the sale. This is step one.

Step 2, There may be tax relief for the 1099C under the Taxation Of Canceled Real Property Indebtedness rules. The fair market value of the property comes into play in this calculation.

Personal insolvency does not come into play in this instance.

[Lee B]

I agree with Jack. Had one these last year. Read Pub 4681 which is fairly well written and some detailed examples.

[Mr. Pencil]

1. To determine insolvency do I use the statement or the cash out amount?

I happen to know that divorce court counts the full pension, even if not vested. But bankruptcy court doesn't count any of it. Tax court is probably somewhere in between. Sometimes for an offer-in-compromise IRS lets you treat a pension as income instead of an asset. So do whatever is best for the client. That probably means only count the vested benefits that are available to offset debt, if the client understands that the IRS might argue about it.

I don't know why people would say insolvency doesn't apply. You CAN'T take the real property business exclusion until after you use up insolvency. At least, that's what it says in that Pub 4681 they tell you to read.. Also you can't use it for the equity line or the interest or any part of the first mortgage that's not acquisition debt. Also, there are some ways to avoid reducing basis.

[Jack from Ohio]

I happen to know that divorce court counts the full pension, even if not vested. But bankruptcy court won't count any of it. Tax court is probably somewhere in between. Sometimes for an offer-in-compromise IRS lets you treat a pension as income instead of an asset. So do what is best for the client. That probably means only count the vested benefits that are available to offset debt, if the client understands that the IRS might argue about it.

I don't know why somebody said insolvency doesn't apply. You CAN'T use the real property business exclusion until after you take the insolvency exclusion. At least, that's what it says in Pub 4681. Also you can't use it for the equity line or the interest or any part of the first mortgage that's not acquisition debt. Also, there are some ways to avoid reducing basis.

I disagree. Real property assets and cancellation of debt are NOT connected to personal insolvency. You must have read a different pub than I did.

Still has to do the sale of the property and may well have a big taxable capital gain. This is first. Personal insolvency does not apply.

[Mr. Pencil]

Final question. What is the advantage of using the insolvency worksheet and form 982 if the amount of insolvency reduces the basis? It seems to cancel out any benefit. What Am I Missing?

The insolvency worksheet is mandatory. The previous post says something about a different Pub, maybe for a corporation, but I'm talking about Pub 4681 which is for individuals and says (middle column page 7) that real property business exclusion doesn't apply to the extent of insolvency. The basis adjustment doesn't affect capital gain because it only applies to NEXT year on whatever assets are left. Maybe just a personal home or car. You didn't say these were recourse loans so COD might not even be an issue. At least pull out the interest that would have been deductible as rental expense anyway.

[ljwalters]

The problem was that they owed more than the basis in the property. What I discovered was that they had (before they came to me) refinanced to buy their new home and rented the old house. They lost their personal residence last year. They couldn't get the renter out of the rent house and a lawyer told them it would be cheaper to sell the property. She sold short. her capital gains using both the sell 1099s and 2 1099c's was over 200,000.

Since the extra mortgage was not to improve the rental it is all taxable. I took the accrued interest off on the E. If I did it wrong please tell me. It is not sent yet.