Small Business CPA Warns of Taxation of abandonments, foreclosures and repossessions
Small Business CPA Office warn foreclosures may alleviate the financial burden on these taxpayers CPA warns of the tax consequences often are overlooked
Small Business CPA Office warns many taxpayers in the current economy have had trouble paying mortgages, car notes, and other debts. Some are forced to abandon the property, go through foreclosures, or have property repossessed. While such measures may alleviate the financial burden on these taxpayers, Small Business CPA warns of the tax consequences often are overlooked.
Small Business CPA warns that when a property that secures a debt is abandoned by voluntary or involuntary action, the tax consequence depends, among other things, on whether the taxpayer was personally liable for the debt and whether the abandoned property was personal use, according to VieraCPA a Small Business CPA.
PROPERTY SECURED BY RECOURSE DEBT
Small Business CPA reminds you that if the debtor is personally liable for the loan on the property is abandoned, the loan is a recourse debt, and until foreclosure or repossession procedures are completed, there are no tax consequences, whether the property is personal use or business use. The foreclosure or repossession is treated as a sale, and the debtor may realize a gain or loss on the deemed sale, according to VieraCPA a Small Business CPA. The amount realized is the lower of the asset’s fair market value on the date of abandonment or the outstanding debt immediately before the transfer, reduced by any amount for which the taxpayer remains personally liable after the transfer. The amount realized also includes any proceeds the debtor received from the foreclosure sale. The amount realized is compared with the debtor’s basis in the property to determine gain or loss.
Small Business CPA warns that the gain from a foreclosure sale of abandoned property is includible in gross income whether or not the taxpayer used the property for business purposes. However, losses from the personal-use property are nondeductible. If the property is a business-use asset, the gain or loss on disposition is either capital or an ordinary gain or loss, depending on the character and nature of the asset. After the foreclosure has been completed, if the financial institution or creditor forgives the debtor any part of the debt, the forgiven portion is the cancellation of debt (COD) income and may be includible in the debtor’s gross income. It is reported separately from any gain or loss realized from the sale, according to VieraCPA a Small Business CPA.
PROPERTY SECURED BY NONRECOURSE DEBT
If the debtor is not personally liable for the debt (nonrecourse debt) and abandons the personal-use property, such as a home or an automobile, the abandonment is treated as a sale in the year of abandonment. The amount realized on the sale—the outstanding loan balance according to Small Business CPA —is compared with the taxpayer’s adjusted basis in the property to determine gain or loss. Any loss is a nondeductible personal expense. If the property abandoned is a business or investment property, the amount of gain or loss is determined in the same way. However, a loss is deductible. The character of the loss depends on the character of the property.
Generally, no COD income arises from these types of transactions because the debtor is not personally liable for the debt. However, if the debtor retains the collateral and accepts a discount from the creditor for the early payment of the debt, or agrees to a loan modification that reduces its principal balance, the amount of the discount or principal reduction is considered COD income, even if the debtor is not personally liable for the debt.
CANCELLATION OF DEBT INCOME
Generally, if a creditor forgives or cancels a taxpayer’s recourse debt, the amount forgiven or canceled is ordinary income to the taxpayer, according to IRS and Small Business CPA. The taxpayer may be able to exclude canceled debt from gross income if the debt cancellation was a gift, or in some cases, if the canceled debt was a student loan, deductible debt, or a price reduction after the original purchase of the property. Sec. 108 also may exclude canceled debt from gross income if the taxpayer was bankrupt or insolvent immediately before the debt cancellation or if the debt is qualified farm indebtedness, qualified real property business indebtedness, or qualified principal residence indebtedness.
This is an overview of some of the principles that are likely to be involved for Small Business CPA clients in these situations. Facts and circumstances may indicate a variety of options and considerations regarding these issues. Small Business CPA can guide clients through such determinations and help them avoid undesirable tax consequences when they must relinquish property securing their debts.
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