Schedule E CPA offers tips on rental property foreclosures | rental property cancelled debt | Insolvency and Discharge of qualified real property business indebtedness exclusions on Form 982 |IRS Form 1099-A and Form 1099-C

Schedule E CPAs work with rental property cancelled debt and Form 982 daily. And, of course, the rental property profit and loss issues on Schedule E, Supplemental Income and Loss, too. I hear lots of confusion and anxiety about rental property Form 1099-C, Cancellation of Debt, and Form 1099-A, Acquisition or Abandonment of Secured Property. And not just from landlords. So I’ll try to cover some rental property tax reporting issues, and hopefully augment the Form 982 instructions, especially on the rental property insolvency and qualified real property business indebtedness exclusions. I’m not dealing with the discharge of indebtedness in a title 11 case, bankruptcy exclusion of Form 982.

Common pathways in rental real estate property cancelled debt For rental property canceled debt purposes the following are sorta kinda the same thing. These are rental property “sales” to the IRS, but I understand they don’t feel like sales.

• Rental property foreclosures.
• Rental property short sales.
• Rental property abandonments.
• Rental property deed in lieu of foreclosures.

Potential issues for rental property sales

• Final year Schedule E, Supplemental Income and Loss, preparation for rental property profit or loss.
  • Remember you can claim prior disallowed passive rental real estate losses in the year of sale. My perception is that some landlords don’t claim prior disallowed passive rental property losses, thereby losing thousands of dollars of legitimate deductions.
• Cancelled debt per Form 1099-C, Cancellation of Debt.
  • I see landlords paying taxes on rental property debt cancellation instead of using IRS Form 982, Reduction of Tax Attributes, to exclude some or all cancelled debt in Box 2 of Form 1099-C.
  • Many Clients don’t receive a Form 1099-C. So check what the IRS has on file for you using their Get Transcript online tool.
  • Form 1099-C may arrive in a future tax year.
• Gain or loss on the sale, reported on Form 4797, Sales of Business Property, via:
  • Form 1099-C.
  • Form 1099-A, Acquisition or Abandonment of Secured Property.

“Don’t pay taxes on rental property cancelled debt, box 2 of Form 1099-C, without exploiting the insolvency and qualified real property business indebtedness exclusions of Form 982. With planning, the bankruptcy exclusion, discharge of indebtedness in a title 11 case, is a “gimme.”
- Gary Bode, Schedule E CPA

What’s the difference between Form 1099-C, Cancellation of Debt, and IRS Form 1099-A, Acquisition or Abandonment of Secured Property?

Form 1099-A doesn’t report any rental property cancelled mortgage debt. It just tells the IRS there was a transfer of title. Form 1099-A usually gives a fair market value for the rental real estate property on the date of transfer. Sometimes I’ll challenge the FMV of Form 1099-A. The IRS uses the FMV listed as a “good” number and the taxpayer has to prove that number is incorrect. Form 1099-A requires the landlord to calculate gain or loss on the rental property foreclosure via Form 4797, Sales of Business Property. In my experience as a Schedule E CPA, landlords caught in rental property foreclosures or short sales have large legitimate losses that turn into large tax deductions. Of course the Form 4797 loss doesn’t cover the landlord’s actual loss. But you might be able to turn lemons into lemonade. IRS Form 1099-C, Cancellation of Debt, shows the amount of cancelled the bank forgave in Box 2. If debt forgiveness occurs soon after the rental real estate property “sale” the bank may not issue IRS tax Form 1099-A.

“Form 1099-C presents the cancelled debt and may include all the information that would have been on Form 1099-A. So, in some cases, the bank doesn’t issue Form 1099-A.”
- Gary Bode Schedule E CPA

Form 982’s qualified real property business indebtedness exclusions and insolvency exclusions

Landlords have three ways to possible ways to exclude rental property debt cancellation on Form 1099-C from taxable income. All use IRS tax Form 982, Reduction of Tax Attributes. The Form 982 instruction aren’t that helpful in my opinion. The real Form 982 instructions are in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. As a side note, Form 1099-C instructions are for the bank, not the taxpayer.

The qualified real property business indebtedness exclusion of Form 982 has two exclusion limits. IRS Publication explains this well.

The discharge of indebtedness in a title 11 case, exclusion of Form 982 is commonly called bankruptcy, which contributes to the insolvency / bankruptcy confusion mentioned above.

IRS insolvency, discharge of indebtedness to the extent insolvent (not in a title 11 case), just means you owe more than the value of what you own. The IRS insolvency worksheet calculates the amount of landlord insolvency as of the date on Form 1099-C. You can exclude cancelled debt on Form 982 to the extent you’re insolvent. There are some interesting IRS wrinkles in the insolvency calculations. And lots of documentation.

“Insolvency isn’t an all or nothing Form 982 exclusion. You might be able to exclude all, some or none of the cancelled debt.”
-Gary Bode, Form 982 CPA

Use Form 4797, Sales of Business Property, to report gain or loss from the “sale” of your rental property

Form 4797 covers a range of gain and loss calculations. I think that’s why the Form 4797 instructions confuse some landlords. With cancelled debt, rental property foreclosures and short sales gain/loss calculations include:

• Basis, the amount you paid for the rental property.
  • I usually ask for the HUD statement because some landlords didn’t include buyer’s settlement costs in the basis.
  • Remember you can’t depreciate rental property land.
• Recapture of depreciation.
  • Even if you didn’t depreciate the rental property over the years you still have to include the depreciation that could have been allowed. Ouch.
• Sales price. If there’s a closing HUD, be sure to claim the seller settlement expenses.

Summary

I think planning is the key to tax savings with rental property foreclosures. Tax positioning strategies exist. When there’s a foreclosure or short sale of your rental property, your Schedule E CPA has three main issues:

• The final year Schedule E. That includes claiming prior year disallowed losses on the rental property.
• Cancelled debt. Your CPA has three ways to exclude cancelled debt on Form 982:
  • Discharge of indebtedness in a title 11 case, bankruptcy.
  • Discharge of indebtedness to the extent insolvent (not in a title 11 case), insolvency
  • Qualified real property business indebtedness.
  • Don’t pay taxes on cancelled debt without looking at all three available Form 982 exclusions.
• Bankruptcy. However most cancelled debt rental property cases I see are past the point where bankruptcy could work. Again planning is prudent.

The actual Form 982 instructions for Schedule E landlords is Publication 4681. But be prepared to read additional IRS info on issues like depreciation, calculating gain or loss on the foreclosure, etc. I think rental property tax reporting rules are complex when there’s a “sale” that generates cancelled debt. I feel it takes some experience and while I advocate tax self-preparation when prudent, rental real estate cancelled debt probably deserves a CPA. If you don’t have a local rental property cancelled debt CPA, consider calling me for a free consult at (910) 399-2705.

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