Tax Prep by Deb Posted February 17, 2010 Report Share Posted February 17, 2010 I have a client who has a rental property. This property has been rented for over 5 years to a family member who is paying the mortgage (it is way above rental FMV in the area). Last year they ran into trouble paying the mortgage and my client went to the mortgage company and was successful in getting the loan modified. Apperantly they didn't read the fine print in all the documents, and needless to say they were issued a 1099-C for around $110,000. The mortgage company lopped off that much from the original loan of over $600,000.00. I know my clients could not prove they were insolvent, but is there any other way to handled this COD income? I was wondering if anyone knows a way of being able to claim an exclusion and then adjusting the basis of the property by the amount of debt forgiven. I have had experience in handling situations where my client lost the home, (not a rental though), but never where they kept the home and was currently using it as a rental. Any thoughts would be greatly appreciated. While my client is not insolvent, the tax debt incurrect from this will be difficult for them to pay. Deb! Quote Link to comment Share on other sites More sharing options...
TAXBILLY Posted February 17, 2010 Report Share Posted February 17, 2010 Did you check page 4? http://www.irs.gov/pub/irs-pdf/p4681.pdf tabilly Quote Link to comment Share on other sites More sharing options...
Tax Prep by Deb Posted February 17, 2010 Author Report Share Posted February 17, 2010 Did you check page 4? http://www.irs.gov/pub/irs-pdf/p4681.pdf tabilly Yes, I did and that is partly why I posted the question. I wanted to make sure I was understanding what I was reading. This is my hoped for response, and it seems logical and reasonable but I'm always a sceptic and do not want anything to come back and haunt me. If it's a legal way to solve this problem I'm all for it. Thanks for the response. Anyone else? Deb! Quote Link to comment Share on other sites More sharing options...
BulldogTom Posted February 17, 2010 Report Share Posted February 17, 2010 Pay very close attention to the limitations and make sure you have all the FMV numbers correct. Tom Lodi, CA Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted February 17, 2010 Report Share Posted February 17, 2010 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. Quote Link to comment Share on other sites More sharing options...
Tax Prep by Deb Posted February 17, 2010 Author Report Share Posted February 17, 2010 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. Thanks K.C. I've been round for round with this one. What do you think however about including it, but having the exception of qualified real property business indebtedness as discussed on Page 5? In your opinion, provided the fmv and other factors that Tom pointed out are met, would this rental property qualify? Deb! Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted February 18, 2010 Report Share Posted February 18, 2010 Sorry, but based on your original post I don't see it, Deb. I think VERY highly of Tom's judgement, but I just don't see what you guys are seeing on page 4? If there is not an insolvency exception, no bankruptcy, and this was not farm debt, what are you looking at? Quote Link to comment Share on other sites More sharing options...
LindaB Posted February 18, 2010 Report Share Posted February 18, 2010 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. Quote Link to comment Share on other sites More sharing options...
BulldogTom Posted February 18, 2010 Report Share Posted February 18, 2010 KC, Keep reading. Page 7 in the pub there is an exception for real estate used in business. There is an example of a store owner who gets a loan modification and keeps his store, but reduces his basis in the building. Files form 982 and reduces tax attributes (basis). There is some debate over rental real estate being a trade or business. I fall in the camp that it does. It is a profit motivated venture. I say the example in the pub fits Deb's situation based on her limited information posted. Tom Lodi, CA Quote Link to comment Share on other sites More sharing options...
jainen Posted February 18, 2010 Report Share Posted February 18, 2010 >>It is a profit motivated venture.<< In my opinion, this property was not acquired or held with a profit motive. According to the original post there was never any hope that rents could cover costs. It was in fact being purchased and used as a family home. Now, I have no hope of convincing anyone on that point, but I daresay the representations would be different if the question concerned the exclusion of capital gain rather than C.O.D. Since even the owner did not read the contract, we can't know what happened in the mortgage office. We do know the borrower had sufficient assets, so I would guess the value of the collateral no longer secured the full amount and the lender reduced the debt to avoid foreclosure when the owner threatened to walk away from the property. In that scenario, the exception for qualified real property business indebtedness might apply. But certainly it is not a reduction in price, as the seller dropped out of the picture years and years ago. [After Tom's post, I edited this concerning the exception for qualified real property business indebtedness.] Quote Link to comment Share on other sites More sharing options...
BulldogTom Posted February 18, 2010 Report Share Posted February 18, 2010 Your point is very well taken jainen. We don't know all the facts and circumstances. However, if the property was purchased as a rental, and they never refinanced, and they intended to make a profit, and they had a plan to make a profit, and they operated the rental with a market rate of rent that covered the costs of the venture, then I stand by my assertion that the exception applies. You are also making some assumptions jainen. I don't see where it was purchased as a family home. I made different assumptions that it was a purchase for a rental and the tenant happened to be a relative. Note the post where it says the rent was way above FMV for the area. If your assumptions are correct and mine incorrect, I would concede your treatment. Tom Lodi, CA Quote Link to comment Share on other sites More sharing options...
Tax Prep by Deb Posted February 18, 2010 Author Report Share Posted February 18, 2010 I do believe Jainen is correct in his assumption. I am going to contact the client this morning, however my feelings are that this house was originally purchased as my clients main home, then when her husband was disabled the children agreed to move into the home, make the mortgage payment which allowed my client to move into a much smaller home that was more affordable. They realize that they should have just sold the property when they could have, and now I'm thinking they wished they had just let it go as this has caused them so much problems. There is so much to this story that if told would break hearts, that's why I would love to soften the blow, but I am beginning to lean the other way. Even though it has been treated as a rental, I do not believe it was purchased with that in mind. I'll confirm with client and let you know later today. Thanks for all of your imput. I'm really getting to hate these foreclosures, abandoment, and forgiveness of debt situations. Deb! Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted February 19, 2010 Report Share Posted February 19, 2010 So it started as the tp's personal residence, and then was converted to rental. Tom about had me convinced, and now I am back to thinking it's no. Because the rent is just covering the mortgage, no profit. On the other hand, she could have sold it to them, so I could argue that she kept if expecting it to raise in value, and provide a profit when eventually sold. Capital appreciation is a valid profit motive, in some cases. On the third hand, she might have kept it on the expectation that the kids would inherit it and get a step up in basis when she dies. Her age and health might tend to support or limit this position. I could probably come up with a couple of more 'hands' if I really tried. But I am sure that Deb will now discuss this with her armed with all our 'bouncing this around' and come up with the right answer. Quote Link to comment Share on other sites More sharing options...
Tax Prep by Deb Posted February 19, 2010 Author Report Share Posted February 19, 2010 So it started as the tp's personal residence, and then was converted to rental. Tom about had me convinced, and now I am back to thinking it's no. Because the rent is just covering the mortgage, no profit. On the other hand, she could have sold it to them, so I could argue that she kept if expecting it to raise in value, and provide a profit when eventually sold. Capital appreciation is a valid profit motive, in some cases. On the third hand, she might have kept it on the expectation that the kids would inherit it and get a step up in basis when she dies. Her age and health might tend to support or limit this position. I could probably come up with a couple of more 'hands' if I really tried. But I am sure that Deb will now discuss this with her armed with all our 'bouncing this around' and come up with the right answer. I did speak with my client today, and yes this was their primary residence. Her husband took seriously ill a few years back and is no longer able to work. They are not a young couple but do have several good years ahead. I believe the reason they kept the house was because their daughter wanted it, and was hoping to be able to refinance it in her name, that did not happen so she just continued renting it by paying the mortage. My client realizes they missed the boat in not selling it when they could have. They never expected the market to take such a tragic turn here in California. This daughter no longer lives in the house (they had to evict her) but another child has moved in and so far seems to be able to make the payment. I would love to make this disppear, but with everyones help, and differring views, I really see no way of softening this. My client is currently working up her financial situation as of the cancelled debt, however I'm reasonably sure that if there is any insolvency it will be so very little. My client is thinking in terms of an offer in compromise, but there again I don't hold out much hope. They aren't what you would say wealthy, but they do own some property, and with the exception of the rental in question, has very little debt. Thanks again for all your imput! If you have any other thoughts, I'm all ears! Deb! Quote Link to comment Share on other sites More sharing options...
BulldogTom Posted February 19, 2010 Report Share Posted February 19, 2010 Dang, jainen got me again. How does he always make the right assumptions. I thought I had him for a change. OH well, I am not as good at reading between the lines as he is. Tom Lodi, CA Quote Link to comment Share on other sites More sharing options...
jainen Posted February 19, 2010 Report Share Posted February 19, 2010 >>How does he always make the right assumptions<< Nothing is what they say it is. Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted February 20, 2010 Report Share Posted February 20, 2010 Jainen and Tom, you two guys crack me up! I'm going home now with a grin on face thanks to you two. Thank you for that! Quote Link to comment Share on other sites More sharing options...
BulldogTom Posted February 20, 2010 Report Share Posted February 20, 2010 I am claiming victory because jainen had to go back and clarify his post. I could call that cheating, but I will just say jainen mis-typed what he thought he was going to say. Now I can bask in the glory of knowing that I made jainen think twice about his position. I win, I win, I win, I win !!!! Tom Lodi, CA Quote Link to comment Share on other sites More sharing options...
jainen Posted February 20, 2010 Report Share Posted February 20, 2010 >>I win, I win, I win, I win !!!!<< No you didn't--you came in second to last! Quote Link to comment Share on other sites More sharing options...
Gloria Posted February 21, 2010 Report Share Posted February 21, 2010 KC, Keep reading. Page 7 in the pub there is an exception for real estate used in business. There is an example of a store owner who gets a loan modification and keeps his store, but reduces his basis in the building. Files form 982 and reduces tax attributes (basis). There is some debate over rental real estate being a trade or business. I fall in the camp that it does. It is a profit motivated venture. I say the example in the pub fits Deb's situation based on her limited information posted. Tom Lodi, CA Tom, in reading your comments above, I was hoping that rentals of real estate would fall under a "trade or business" but that is not the case based on the following: Publication 925 - Main Content Trade or Business Activities A trade or business activity is an activity that: • Involves the conduct of a trade or business (that is, deductions would be allowable under section 162 of the Internal Revenue Code if other limitations, such as the passive activity rules, did not apply), • Is conducted in anticipation of starting a trade or business, or • Involves research or experimental expenditures that are deductible under Internal Revenue Code section 174 (or that would be deductible if you chose to deduct rather than capitalize them). A trade or business activity does not include a rental activity or the rental of property that is incidental to an activity of holding the property for investment. Quote Link to comment Share on other sites More sharing options...
kcjenkins Posted February 21, 2010 Report Share Posted February 21, 2010 You are right Gloria, the code makes a clear distinction between "trade or business" and "rental activity". Both are profit-motivated, but each has it's own rules. Just as business assets and residential rental assets can both be depreciated, but have different rules for doing so. Quote Link to comment Share on other sites More sharing options...
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