Tax implications of repossessed s. corp trucks

[Vityaba]

A trucking S Corp is going out of business and all tucks were repossessed. The owner was a personal guarantor on all loans. The lenders are going for him personally and most likely hi will file ch 7 bankruptcy sometime next year.

How do we go about calculating of gain/loss on the "disposition" of these trucks. In most cases FMV of the trucks is lower than basis which creates a large loss this year. Do I reduce the basis by the amount of FMV-loan, or since the debt was not cancelled yet we cannot do that and have to show the loss.

 

 

[Abby Normal]

I have zero experience with this, so everything that follows is just thinking out loud.

The FMV of the trucks is not important here, only the undepreciated value. And I think the loan amounts are the proceeds for the disposition of the trucks. So the S corp would have a gain or loss on disposition of the trucks.

So if you think about the components of this transaction separately, the loan amounts are increasing the shareholders stock basis by increasing income, and he's getting a full write off of the trucks.

He may end up with a 1099-C personally for the cancellation of the debt, but if he's declaring personal bankruptcy, that won't be income to him.

 

[Vityaba]

No, that's not correct. 

From Pub 544: 

Buyer's (borrower's) gain or loss.   You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. 

Amount realized on a recourse debt.   If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of:

• The outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or

• The fair market value of the transferred property.

You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. The amount realized does not include the canceled debt that is your income from cancellation of debt. See Cancellation of debt, below.

So let's say a TP has a truck with basis $100,000. Outstanding loan at the time of repo is $110,000. FMV is $80,000. So according to the Pub 544, the amount realized is $80,000, which will create $20,000 loss this year. My concern here is that if next year the debt will be cancelled due to bankruptcy and won't be subject to the income tax the TP will end up with $20,000 loss, when in reality this should have been $10,000 income due to cancelled debt, or at lease zero...

 

[easytax]

Also NOT familiar here but a question for Vityaba       Is not there two separate and distant occurrences here (basically from your " Amount realized on a recourse debt." shared above. The S corp is a separate entity (even if owner, etc.) is separately liable; therefore would not the S corp gain/loss be just the difference from adj. basis and the "sell" price?  Whereas the "personally responsible" owner would be a different calculation?

 

[Vityaba]

Easytax, yes, these are separate calculations, but since this is a S Corp, its calculations flow through to the owner and create large loss on his return. If the 1099 was during the same year that loss would have been offset by the COD income. But if there will never be COD income (due to bankruptcy), it turns out to a large tax advantage to the TP. I am worrying that I may be missing something and I actually do need to reduce the basis by the COD. The problem also is that at this point there is no COD yet. It may occur next year

 

[Abby Normal]

You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. The amount realized does not include the canceled debt that is your income from cancellation of debt. See Cancellation of debt, below.

The overview is still that the total amount of the debt is income (at the corporate level) and the total undepreciated value of the trucks is expense. The debt is just being split between cap gain income and ordinary income.

[Abby Normal]

 The problem also is that at this point there is no COD yet. It may occur next year

 

There is possibly COD income at the corporate level this year and that passes out to the shareholder, which in turn increases his basis to allow more losses to be currently deducted.