What is worse than Carmeggdeon? Getting tax forms saying that you have debt issues. That isn’t profitable! i call that Debtoggedden.
If you are one of my clients who receive a Form 1099-A, Acquisition or Abandonment of Secured Property, or Form 1099-C,
Cancellation of Debt, you may have to report income on their tax return. Foreclosures and repossessions may be a delicate topic for some of you guys and gals. I try to be be sensitive to my client’s situation (that is part of the great service I provide).
You get a Form 1099-A, when a lender acquires an interest in property that is security for a debt, or they have reason to know that the property has been abandoned. A very common example is foreclosure of real property. When a client receives Form 1099-A for the repossession of a principal residence, it is treated as a sale of the home. To determine if the client has a gain, the Sale of Home Worksheets must be completed. It will help you also see if you are profitable or not.
If the client has a gain and the property was personal-use, it is reported on Schedule D. If it was business-use property, it is reported on Form 4797. The client may also have cancellation of debt income.
The three parts of the Sale of Home Worksheets are:
• Worksheet 1, Adjusted Basis of Home Sold
• Worksheet 2, Gain (or Loss), Exclusion, and Taxable Gain
• Worksheet 3, Reduced Exclusion Worksheet
Worksheet 1, Adjusted Basis of Home Sold
The adjusted basis of the home is calculated the same for a repossession as it is for a sale. The adjusted basis is generally the purchase price of the home plus any home improvements.
Worksheet 2, Taxable Gain on Sale of Home
The selling price is needed to calculate the gain (or loss) on the home. The selling price will usually be provided by the bank. If not, the selling price is determined from Form 1099-A.
If the client is personally responsible for the debt, the sales price is the lesser of box 2 or box 4 on Form 1099-A. If the client is not personally responsible, the sales price is the amount in box 2.
Part 1 of this worksheet determines whether or not there is a loss on the property. If line 5 of the worksheet is a negative number, the client has a loss. Do not complete line 6 through line 11. If line 5 is a positive number, complete Part II to determine the gain.
Worksheet 3, Reduced Maximum Exclusion
Since a repossession of a home is treated as a sale, the gain can often be excluded. The exclusion rules are the same as the exclusion rules for the sale of home. The worksheet is used to determine if the gain qualifies for an exclusion.
Form 1099-C is received when a client borrows money from a commercial lender and the lender later cancels or forgives the debt. The most common examples of cancelled debt are from credit cards and repossessions. There is a lot of that going around these days.
Cancellation of debt income is taxable unless the client is bankrupt or insolvent, or unless the debt is qualified property under the Mortgage Forgiveness Debt Relief Act of 2007.
Mortgage Forgiveness Debt Relief Act of 2007
Under the Mortgage Forgiveness Debt Relief Act of 2007, the discharge of qualified principal residence indebtedness is excluded from gross income. For purposes of the exclusion, qualified principal residence indebtedness is acquisition indebtedness (to buy, build, or improve the residence) up to $2 million ($1 million for MFS). The home must be owned and used as a principal residence (within the meaning of §121). The basis of the home must be reduced (but not below zero) by any debt forgiveness excluded under this provision.
If only a portion of the loan discharged is qualified indebtedness, the exclusion applies only to the amount of debt discharged that exceeds the amount of the loan that exceeds the nonqualified indebtedness.
If the debt was cancelled in Chapter 7 or 11 bankruptcy, box 1(a) on Form 982, Reduction of Tax Attributes due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) must be checked.
Clear as smoked glass huh (I would have said mud but that is cliche).
Let me know if you have any questions.
That should help heal the wounds of Debtoggedden.
Oct 02 2012
Kim Isaac Greenblatt
Watching for Tax Debtoggedden