Cancellation of Debt CPA discusses the Insolvency and Discharge of Qualified Real Property Business Indebtedness exclusion of Form 982 | Rental Real Estate Cancelled Debt

I’ll cover cancelled rental real estate debt using the insolvency and discharge of qualified real property business indebtedness exclusions of Form 982. Hi, I’m Gary Bode, a Form 982 CPA with a virtual office. I’m sorry you lost your rental property investment. If you like what you read, consider calling for a free consult on rental property cancelled debt. Tax reporting for the real property business indebtedness exclusion of Form 982 is highly individualized, especially with an S Corporation or Partnership. You can’t reasonably rely on this post for tax preparation advice.

“Sometimes the rental real estate property foreclosure or short sale generates a nice tax-deductible loss. Sort of a making lemonade out of lemons scenario.”
- Gary Bode, cancelled debt CPA

Typical Rental Property Cancelled Debt Logistics

• The landlord runs into financial hardship and stops making mortgage payments:
  • The bank forecloses on the rental property.
  • The landlord is forced into a short sale of the rental property.
  • The landlord abandons the rental property.
  • Or, the landlord works out a deed in lieu of foreclosure arrangement with the bank.
• Form 1099-A, Acquisition or Abandonment of Secured Property.
  • Sometimes the bank doesn’t issue Form 1099-A and instead immediately issues the notorious Form 1099-C, Cancellation of Debt.
  • A reports a title transfer to the bank triggering an IRS reportable “sale” of the rental real estate property resulting in a taxable gain or loss via Form 4797, Sales of Business Property.
  • Form 1099-A doesn’t generate rental property cancelled debt.
  • Generally a Form 1099-C gets issued eventually, but that could be in a future tax year.
• Form 1099-C, Cancellation of Debt.
  • Again, the bank may skip issuing Form 1099-A and directly issue Form 1099-C.
  • Form 1099-C also triggers an IRS reportable sale of the rental property described above.
  • The amount of cancelled debt in Box 2 of Form 1099-C becomes taxable income.
• The S Corporation, Partnership or individual prepares Form 982, generally using the insolvency and or qualified real property business indebtedness exclusion.

“Having your rental real estate property go south is bad enough. Don’t pay taxes on the cancelled debt without exploiting the insolvency and qualified real property business indebtedness exclusions of Form 982.”
- Gary Bode, cancelled debt CPA

The Tax Reporting Logistics of Rental Property Cancelled Debt

• Partial year preparation of:
  • Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation.
  • Schedule E, Supplemental Income and Loss.
• Calculation of gain or loss on Form 4797, Sales of Business Property.
  • Both Form 1099-A and Form 1099-C have a Fair Market Value listed for the rental property at the time of deed transfer.
  • The IRS assumes Form 1099-A and/or Form 1099-C is accurate.
  • Sometimes I show there’s a better number for the rental property FMV.
  • Rental property cancelled debt tax returns often include additional documentation and explanations.
  • I’ve seen landlords shocked when their loss is less than what they expected, or worse yet, turns into a gain. Form 4797 requires more than just the applicable sales price and original purchase price.
    • The most common example is the recaptured depreciation part of Form 4797.
• Preparation of Form 982 - exclusion of cancelled rental property debt from taxable income.
  • The amount in Box 2 of Form 1099-C, Cancellation of Debt, becomes taxable income unless the landlord can exclude some or all of it through Form 982.
  • Landlords may use both the insolvency and qualified real property business indebtedness exclusion of Form 982.
  • Both the insolvency and qualified real property business indebtedness exclusion of Form 982 have IRS tax reporting rules.
• Preparation of the Reduction of Tax Attributes section of Form 982. I’ve found an example communicates the main aspect this IRS concept best. But few things are straight forward in rental property cancelled debt.
  • Let’s say you have two rental properties. One got foreclosed in 2013 and you received a Form 1099-C.
  • You managed to exclude $100,000 of cancelled debt through the insolvency and /or qualified real property business indebtedness exclusion of Form 982.
  • You decrease the basis (purchase price) of the remaining rental estate property by $100,000 on 2013’s Form 982 as required by the IRS.
  • You sell the remaining rental real estate property in 2014.
  • The 2014 sale generates $100,000 less loss or $100,000 more gain because of the 2013 Reduction of Tax Attributes.
  • Sometimes you can plan to minimize this tricky part of rental property cancelled debt. But that takes time and experience.
  • Moral of the Reduction of Tax Attributes story? Exclusion of rental property cancelled debt often just delays paying the tax until you sell another asset.

Sources of help with Form 982 and the rental property cancelled debt tax reporting process

• Individuals - Schedule E and Form 1040 filers.
  • The Form 982 instructions.
  • Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments).
  • Note the Form 1099-C, Cancellation of Debt, instructions are for the bank not the taxpayer.
• S Corporation and Partnerships - Form 8825 and Form 1120-S/1065 filers.
  • The Form 982 instructions.
  • The underlying IRS regulations.

Rental property CPAs have access to specialized tax services where the relevant insolvency and qualified real property business indebtedness exclusion issues are laid out logically. Sometimes anyway. The average landlord can’t afford these services and would be hard pressed to understand them without a strong tax preparation background - sorry. But your local university might subscribe to some tax database you could use.

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