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Edsel

4797 on Bankruptcy??

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A so-called farmer claimed a huge loss ($200K) to offset large income ($395K), and was later ruled to be a hobby by the IRS.

For this and other reasons he ended up owing the IRS a ton of money, several hundred thousand dollars.  The IRS seized his assets, including $150,000 worth of farm equipment.  Most of the farm equipment (but not all) was fully depreciated because of s.179 treatment.

The IRS used the equipment to absolve the taxpayer of $ w,xyz.00 of debt owed to the IRS.

Question:  In the year that the seizure occurred, is the taxpayer obligated to report a 4797 transaction showing $w,xyz.00 as proceeds from the sale?  If not shown on 4797 does the transaction get reported as income any other way?

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Just thinking out loud, but reporting it as a sale of business asset, wouldn’t it put the taxpayer at a further tax burden?

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Yes it would increase his tax burden in the year of the seizure/absolution of liability.  But he did give up the equipment in exchange for something of value.   Interesting question, Edsel.  I am not sure if it would be sale on a 4797, or cancellation of debt.   And how would this affect the 179 deduction - does some or all of that need to be recaptured since the property is no longer business use? 

I hope somebody else weighs in on this - you have me wondering now. 

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I'm also thinking out loud, and I have no direct experience with this but do think this would fall under the category of involuntary conversions that includes seizures. When the IRS sells the property to satisfy the debt, if it ends up with excess proceeds, those funds are returned to the taxpayer. Doubtful that would ever happen, but it does seem that this would be reported as a sale.  

Also to consider when reporting this is that the IRS tallies up all costs associated with the seizure including costs to remove and sell the property, and if the sale does not go through or property is returned to the taxpayer, those costs incurred by the IRS are added to the balance owed to the IRS by the taxpayer. With that in mind, I would think that those costs incurred would be considered additional expenses of "sale" that would reduce any resulting gain from the transactions.

Lastly, if any personal property was seized and sold, remember that a loss from the sale of personal property isn't deductible, but any resulting gains would be taxable. 

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Thanks to all who have participated in this, and it seems to me Judy's answer is more reasonable than anything I had imagined previously.

A little extra spice - taxpayer claimed bankruptcy, although it is unclear to me whether the bankruptcy was concurrent with the seizure.  Of course, bankruptcy does bail anyone out of taxes, so the bankruptcy could be irrelevant.

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I don't know if this helps or what other assets were involved, but the IRS gets in line behind those that already have a claim if the property is collateral on an existing loan such as a mortgage on real estate or others with a security interest in the property seized.

There are some strict rules where Ch 7 bankruptcy can eliminate some tax debt, but that is a straight outright bankruptcy and not a reorganizing or restructuring.

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12 hours ago, Edsel said:

Most of the farm equipment (but not all) was fully depreciated because of s.179 treatment.

Was that disallowed by the IRS?  If ultimately there was no tax benefit then I would not report on 4797. 

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I also would not report this on 4794  If IRS audit said no farm business then they disallowed any deduction on the "farm" equipment.

So it would only be reported on Schedule D if a GAIN  personal loss not deductible. 

All deduction for 179 would have been taken care of in the audit.

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11 hours ago, grandmabee said:

I also would not report this on 4794  If IRS audit said no farm business then they disallowed any deduction on the "farm" equipment.

So it would only be reported on Schedule D if a GAIN  personal loss not deductible. 

All deduction for 179 would have been taken care of in the audit.

Edsel didn't give us enough facts to definitively determine if it was all disallowed, but it is a good point and Edsel should know. We don't know for sure what adjustments the IRS made and if the adjustments were for all years of farm activity. 

Edsel, were there were any profitable years, or if there were eventually so many loss years that the TP eventually ran into the hobby loss rules?  

Too late now to do anything now, but I'm curious if you tried to argue the point that your client did have a profit motive based on cash flow before the depreciation deduction.  It's been many years, but I had a very similar scenario with depreciation causing losses each year that the IRS questioned, and we ended up with no changes on examination, and this exam was one where the IRS requested invoices for every expenditure on the return.  The agent was so beligerent, she tried to disallow his business deduction for trash collection on a multi-unit apartment complex saying that the TP was driving for miles and miles with his own trash to deposit in the bin, and the expenditure was too high compared to what she paid at her private residence!  We shut that down by providing his own trash bills and I finally had to get her supervisor involved for stupid 💩 she was dreaming up.

 

Edited by jklcpa
removed link, not same client
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The reference from 2017 provided above was for someone else.

I don't know all the facts that are missing, for the time being second-hand information.  We've ordered 4506-T to see what information the IRS can provide.

Thanks, Edsel.

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