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Rental property & 982/Insolvency question?

Discussion in 'Short Sale Outpost' started by tyerac, Feb 13, 2010.

  1. tyerac

    tyerac LoanSafe Member

    Hey guys,

    So i'm just about to go through my taxes for last year and I have a 1099-C for a rental I short sold in 2009. The 982 Deficiency workout sheets seem simple enough and it seemed that I was very insolvent, more than what my 1099-C was forgiving me for so I thought i'd have no tax liability on it. Well my CPA tells me that I can only claim a portion of insolvency and not the much higher amount I had worked out on my 982 worksheet even though my assets were FAR LESS than liabilities. She directed me to a piece of wording that helps explain why I couldn't claim the full insolvency amount on my rental but I have no idea what the heck it means? Can anyone help me translate what this means? Here is the verbiage:

    From IRS publication concerning Insolvency & Short sales:
    "One more exception applies if your rental qualifies as Section 1231 property. In this case, you may be able to reduce the cost basis of the rental property without being insolvent. The result is that you don’t report the income from the debt forgiveness but you have a lower loss on the “sale’ of your property. To use this strategy, you must make an election and the debt forgiven must be “qualified acquisition indebtedness,†(i.e. debt incurred to acquire, construct or improve a property.)"

    Again anyone know what this means? Is my CPA looking at an alternative option that is leaving me not able to be insolvent up to the forgiven amount? My liabilities are FAR in excess of the amount forgiven so I should be easily covered taking that route, but do rental's have a different set of guidelines?

    Thanks in advance

  2. HopingtoFind

    HopingtoFind LoanSafe Member

    I started looking into this after you have posted. We have a similar situation to yours. Short sold a rental property in October 2009, although ours was purchased as primary and ended up to be a rental. Received 1099-c for both 1st and 2nd.

    The way I understood this is that if you qualify your property as Section 1231 property then you have another option, other then being insolvent at how you would go about reducing your income tax resulting form cancellation of debt.

    One thing I would be interested to hear and we are going to be consulting a CPA in regards to this as well is why you couldn't use insolvency to reduce your income tax if your assets are FAR less then liabilities.

    To me qualifying property as section 1231 is an option rather then requirement. So for example if you are not insolvent by enough to reduce your income tax you could go with section 1231.... at least that is how I understood it.
  3. tyerac

    tyerac LoanSafe Member

    Hey Hopingtofind.... thanks for your reply!! funnily enough our situations are not too dissimilar at all! Our rental used to be our primary residence too until we moved out to get a larger house. We had it under contract and stupidly signed papers on the new home a week before the first closed and of course it fell through before it could close. We then rented it out for several years before finally giving up the ghost and pursuing a short sale on it.

    We had lived in it for at least 2 years and thought we could use the whole primary residence exemption but of course we quickly found out we could not so Insolvency became our biggest hope. We worked out that we should be insolvent $106,000 and our 1099-C forgiven balance was 99k so we were good? Our only question that we cannot figure ut is when working out the asset/liability list on the 982, is do we include just the liability of the difference between FMV and what we owed on the rental? or both? IRS state that we should include all assets & Liabilities IMMEDIATLY BEFORE the debt was forgiven, and seeing as out property short sold a week before the debt was forgiven, we only had a liability and no asset! Either way even including both the Asset & liability we were under over $100k.

    So from the 1231 property it is simply a way to reduce our cost basis even further before we then look at insolvency? Meaning it is helpful rather than hurtful to our situation?

    I'm glad to hear the lender also 1099'd your 2nd too... ours refused to, and has now charged it off. It's only $15k so we are going to just wait until some nasty collection company tries to collect then try and settle with them. We aren't planning on buying for at least another 5 years so were not in a huge rush to tidy that up.

    We will have to keep in contact to update each other on how we get on. It's like a unknown path we are treading so any support from people swapping stories can only help?

  4. HopingtoFind

    HopingtoFind LoanSafe Member

    Yes, sounds very similar.

    Are you saying that you included the property that you have Short Sold in your insolvency calculations? I didn't think you could do that. Did you CPA say you could? If you were over $100k insolvent, why did your CPA say that you couldn't claim full insolvency.

    If you classify property as 1231, the way I understood it is that you don't even use insolvency... but I can't say I have a complete grasp of this Section 1231 option.

    Yes, our 2nd 1099-c forgiven debt was $90K, but our 2nd was non-recourse, we never refinanced it, so I would have let it go into foreclosure if they didn't.

    Yes, definitely. Lets do that.

  5. tyerac

    tyerac LoanSafe Member

    Yes, you can include a rental property in with an insolvency calculation because its both an asset & liability so needs to be calculated with everything else. However with that said... I'm just stuck on the timing and whether we include just the liability immediately before (As the asset portion was sold the week prior so the Asset has gone, and were only left with a liability)

    Here's a quick example:

    mortgage remaining on 10/1/09 - $220,000
    FMV of property on 10/1/09 - $120,000

    Short sale closed for $120,000 on 10/1/09 leaving balance of $100,000
    This balance was forgiven on 10/5/09, BUT IRS stated we have to include Assets & liabilities immediately before debt forgiven, so if immediately before means previous day that would be 10/4/09. This would mean we didn't have an asset because that sold on 10/1/09, we just had a remaining liability of $100,000 (It wasn't forgiven until 24 hours later on the 5th).

    So on the Form 982 we show a liability of $100,000 but no Asset because that sold 4 days prior.

    Remember they state that you have to include all assets and liabilities, and it does not say anywhere about excluding the short sold property. This is what I have confirmed by the IRS & in writing on the IRS websites.

    Anyway this is what were pitching to our CPA and we meet on Wednesday to find out if were correct, and also more about what she's doing r.e the 1231 business.

  6. HopingtoFind

    HopingtoFind LoanSafe Member

    This is something I found:

    Debt Forgiveness Income

    Debt forgiveness income is the difference between the loan amount at the time of the foreclosure or short-sale and the market price or sale price. While Congress did provide tax relief for debt forgiveness income related to a principal residence, debt forgiveness income continues to be taxable for rental properties. However, there are two basic exceptions to this general rule:
    (1) When the amount forgiven/deficiency is included in a bankruptcy filing.
    (2) When you are insolvent at the time the debt is forgiven.
    One more exception applies if your rental qualifies as Section 1231 property. In this case, you may be able to reduce the cost basis of the rental property without being insolvent. The result is that you don’t report the income from the debt forgiveness but you have a lower loss on the “sale’ of your property. To use this strategy, you must make an election and the debt forgiven must be “qualified acquisition indebtedness,” (i.e. debt incurred to acquire, construct or improve a property.)
    1 person likes this.
  7. tyerac

    tyerac LoanSafe Member

    LOL, yeah I found that too... the last paragraph was the basis for my original question I posted!! :)

    So I think Insolvency is going to be the target here for us. Oh by the way, had a question about your 2nd.... was the 2nd a HELOC? or other type of loan? We refinanced our first and got a 2nd out so maybe tats why it was treated differently than yours? Did you take your 2nd out for an 80/20? I know they are treated differently than getting a HELOC later like I did?
  8. HopingtoFind

    HopingtoFind LoanSafe Member

    Yes, that make sense, please let me know what your CPA says in regards to this. That would make a lot easier to qualify for insolvency.

    This is how insolvency is defined by IRS.

    • Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
    So I wonder that when debt is canceled if we still can claim liability for that debt.
  9. HopingtoFind

    HopingtoFind LoanSafe Member

    Our 2nd was Equity Home loan considered different from HELOC.

    It was taken as part of 80/10/10 at the time of purchase... we put down 10%.

    Thankfully we refinanced 1st with the same lender but not 2nd, we wanted to, but lender refused to re-fi 2nd.
  10. tyerac

    tyerac LoanSafe Member

    Yes that's the big question for us!! In my eye's listing debts IMMEDIATELY BEFORE a debt was forgiven either means we list just the liability as stated above, or both the asset & liability but at least one of the two.

    It makes no sense looking at insolvency if we cant include the debt that is making us insolvent in the first place!, but then again this is the IRS and some things I read are far from logical!

    I will keep you updated on my progress. Please also share any information you may find! I have been Reading a lot of posts here on this site and everyone stresses the importance of retaining a good CPA, this is the first year i've worked with this person so im hoping they fall in the "Good" side :)

  11. HopingtoFind

    HopingtoFind LoanSafe Member

    Yes, please do, I will as well, we still have to find a CPA who is experienced in Short Sales and Foreclosures.
  12. tyerac

    tyerac LoanSafe Member

    Hmm thats a good point. When would imply not including it in with the calculations. I still dont understand why we wouldn't seeing is the object of the 982 is to work out out our solvency based on the taxable forgiven debt we incurred... but it's worth looking at this in more detail.

    Another thing that helps us here is our primary house. We had a mortgage for $220,00 and its worth $130 FMV, so that $90k difference will also help is massively for the insolvency.
  13. HopingtoFind

    HopingtoFind LoanSafe Member

    I looked at our 1099-c forms and according to them debt was canceled on the day of the closing. So at that point I guess there wouldn't be liability or asset as far as the property that was closed.
  14. tyerac

    tyerac LoanSafe Member

    Interesting... our 1099-C says debt cancelled 10/5 but the house closed on 9/30.

    Wonder if they are supposed to match up in any way?
  15. cobjosh

    cobjosh LoanSafe Member

    this is a really interesting catagory ( the 982 form)
    but here is one for maybe you guys can answer on the form why are you guys claming insolvency if you are in california this loans are nonrecourse loans why would nt you file out the the 1042 form and file for a gain or loss ,
    I am in the same situation I gave up my rental property and I got a 200,000 dept forgivess from the bank so the way I am going about it is file it as a gain or loss (1042form) by the way I have read the IRS form is you also have to write down the depreciation you took throgh out the years you own the home.

    but I am still confuse on the 982 form I am trying to see how some of you guys are going about this.
  16. tyerac

    tyerac LoanSafe Member

    Hey, found a very interesting article here: TaxAlmanac - Discussion:Reduction of Tax Attributes for Rental Short Sale

    Scroll down to the post by DaveFogel. It's a little long winded but states the definition of when to work out insolvency. He writes "Remember that the extent of the taxpayer’s insolvency must be measured after the short sale but just before the lender cancels the loan, so it should not include the FMV of the rental property. See IRC §108(d)(3)."

    Let me know if the rest of his post makes sense? There's something we need to take into account which is a Reduction of tax attributes.

    Do you know anything about this?
  17. HopingtoFind

    HopingtoFind LoanSafe Member

    That is very good explanation, I had to re-read it a couple of times to understand what he was saying.

    But basically the way I understood it is first you apply insolvency exclusion, and if you're insolvent by enough to cover the amount of canceled debt then you're done.

    But if for example you're insolvent by $50k and your canceled debt is $100k, they you can use what he calls as a QRPBI exclusion (Section 1231 qualified property), to exclude left over $50k.

    I think by tax attributes he probably means whatever one uses to decrease their taxable income, like depreciation for example.
  18. HopingtoFind

    HopingtoFind LoanSafe Member

    This part I found very confusing:

    My guess is that you calculated the taxpayer’s insolvency of $216,000 by taking into account that the rental property was an asset worth $350,000. Since insolvency is measured immediately before the debt is canceled, you should probably remove this asset from your calculation, and as a result, the extent of the taxpayer’s insolvency is probably more like $566,000.
  19. tyerac

    tyerac LoanSafe Member

    So basically he's saying that the house sells first, and then your left with a liability of remaining amount debt (Even if they forgive the remaining debt the same day, there is still a window of time in-between where you have a liability that has remained after the asset portion sold) And because insolvency is measured in this exact point of time, you add the liability portion to your liability list on the 982 but there is no asset. So he's explaining that the total liabilities is in fact much more because the original example the person put the Asset portion down also when they should not have, because again insolvency is measured immediately after house sells (Asset gone) BUT right before the remaining debt is forgiven.

    Same thing as I was mentioning above, although he does a much better job of explaining it and quoting sources. :)
  20. HopingtoFind

    HopingtoFind LoanSafe Member

    So liability in his example is $647K (total debt) and asset is $350k (FMV).

    $647k - $350k = $297k (difference between liability and asset). His original calculation for insolvency is $216K.

    If he removes $350k from the assets, then he should be adding either $647k??? to insolvency amount, I could even understand adding $297k. But he adds $350K.....

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