Discussion:Reduction of Tax Attributes Short Sale
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Discussion Forum Index --> Tax Questions --> Reduction of Tax Attributes Short Sale
| 8 February 2010 | |
| I have read DaveFogel's comments on this issue, but basically want to know if I'm understanding this complicated issue.
My client had COD income from the short sale of his rental. The 1099-C he received had 0 listed as FMV, however, I have the HUD 1 which shows the property sold for $170,000. The amount of debt discharged was $131.000 (listed on the 1099-C). The bank reported the difference between the total debt outstanding, $275,000 and the amount accepted through the short sale, $144,000, as COD to my client. That's why a 0 FMV, I guess. Client's basis in the property is $248,000 less accumulated depreciation of $23,000: So $225,000. Client is insolvent by the whole amount of the COD income. Client has $50,000 in passive activity (rental) loss carryovers that were suspended but are now available in 2009 thanks to the disposition. Where I'm having an issue is in understanding the reduction of tax attributes. I know that that the reduction of passive activity loss carryovers occurs after the reduction of basis in depreciable assets (or in real property held as inventory) in the ordering rules. I also understand that any basis reduction applies in the year following discharge. That means that the rental will not have its basis affected by the COD exemption, as it was sold in 2009. That leaves only his principal residence available for basis reduction in 2010. Client does not appear to be eligible for the QRPBI exemption as he only owned this one rental and had a full time job. It was not a business. Therefore, I am planning on reducing his 2009 passive activity loss carryovers of $50,000 to 0 in 2009--because there is no other investment property with depreciable basis with which to reduce. Then I am planning on reducing the cost basis of his primary residence by the difference ($131,000 less $50,000 or $81,000) starting January 1, 2010. Is this correct? Form 982, line 10 b, says to only reduce basis of principal residence if line 1e (discharge of qualified principal residence indebtedness) is checked. Line 1e is not checked as this is discharge of indebtedness due to insolvency. This is a confusing area. Thanks for any help... | |
| 8 February 2010 | |
| To begin with, I believe that the proper amount of COD income is $105,000 ($275,000 principal amount of debt minus $170,000 FMV of property).
The QRPBI exclusion CAN apply in the case of a single rental property. See Chief Counsel Advice 200919035 (http://www.irs.gov/pub/irs-wd/0919035.pdf). However, since your client was insolvent, the insolvency exclusion takes precedence. See IRC §108(a)(2)(B). You indicate that there are two "tax attributes" that can be reduced: the basis of the property and the passive loss carryover from 2008 to 2009. As you correctly state, the basis of the property is reduced on Jan. 1, 2010. I believe that the passive loss carryover (if any) is also reduced on this date. See IRC §108(b)(2)(F): (F) PASSIVE ACTIVITY LOSS AND CREDIT CARRYOVERS.—Any passive activity loss or credit carryover of the taxpayer under section 469(b) from the taxable year of the discharge. Note the word "from" that I have highlighted. As a result, I don't see that the $50,000 of passive loss carryover from 2008 to 2009 needs to be reduced on the 2009 return. As a result, the client gets to deduct the suspended passive losses for the property that was sold. Any remaining suspended passive losses from 2009 to 2010 get reduced. I'd like to hear from others as to their opinions on this question. | |
| 8 February 2010 | |
| Thanks Dave, I appreciate your expertise. As you say, the insolvency takes precedence over the QRPBI, so I guess the QRPBI is a moot point, though good to know for future instances. My only problem I guess is conceptual. If the passive loss carryover does not have to be reduced in the year of discharge, and there is no other property to reduce in 2010 (except his principal residence) then the IRS is completely out of luck. My client would not only have a loss on the sale of the rental, he would also be able to offset his income by the $50,000 carryover. Now why would the government do that?
Also, I see what you are saying on the COD income of $105,000, but entering it as such would contradict the 1099-C. Are you thinking the 1099-C is wrong? | |
| 8 February 2010 | |
| "Now why would the government do that?" Because that's what the statute says. IRC §108 is essentially a deferral section --- it defers the income to a later year by affecting other tax attributes. In your case, the client would reduce the basis of his personal residence, which would increase the gain upon sale in a later year.
"Are you thinking the 1099-C is wrong?" They often are. As tax return preparers, we are responsible for preparing a correct return, not one that simply accepts incorrect numbers on an information return. Just to be safe, however, I recommend attaching a statement to the return to explain the discrepancy between the correct numbers and the numbers on the Form 1099-C. | |
| 8 February 2010 | |
| Spidell has a description of "Depreciable basis limitation" and "applying the basis reduction" that's followed by an example (Mr and Mrs Franklin). Would that apply?
[This post has been edited to remove material under copyright by Spidell, in accordance with TaxAlmanac's copyright policies.] | |
| 9 February 2010 | |
| I recognize this from Spidell. That's because I WROTE IT!!
It deals entirely with the QRPBI exclusion, which doesn't apply in your case because the insolvency exclusion takes precedence. | |
| 9 February 2010 | |
| Wow! Talk about going straight to the source. Thanks Dave. In your opinion, why would the IRS treat the two so differently when they are both COD exclusions. One reduces the basis of the rental when calculating gain/loss in the year of disposition (QRPBI); and one defers the reduction in basis to the next year, when there may or may not be carryovers or depreciable property to reduce by the COD exclusion (Insolvency). | |
| 9 February 2010 | |
| The IRS is only following the law. There are different rules for reducing "tax attributes" when the taxpayer elects to exclude the COD income using the QRPBI exclusion. IRC §108(c)(1)(A) requires the taxpayer to reduce the basis of depreciable real property, and IRC §1017(b)(3)(F)(iii) requires the basis to be reduced immediately before the disposition of the property. | |
