As with all things dealing with income taxes documentation is a must. Since you are dealing with personal, business, or investment use property, it is imperative that you have good documentation for all figures you use in your calculations. The exclusion of CODI and the lack of claiming a deemed sale taxable gain, on the proper forms, is one of the “high risk” audit items at the IRS.
When dealing with your business and investment items you need the same type of documentation that you would use to determine basis for disposition. If the item has been in service and has been depreciated, a copy of the current depreciation worksheets are a great starting point. However, also be ready to show where the original figures on that worksheet came from.
Brokerage statements, bank statements, prior year W2s, prior year tax returns, business profit and loss statements, employer retirement plan statements, and tax assessments are all also good items to have.
If the client does not have some of their documents you may look at places like the country assessor’s office and real estate offices for comparable sales reports. Online search engines like www.zillow.com can help with appraisal value for real property and other family member’s records or statements are all acceptable documentation for family property.
You and your client must do your homework properly, especially when dealing with foreclosure and repossession of property. The bank has no need, or desire, to establish the proper FMV of a piece of property it sells after seizure. Normally the FMV blocks on the 1099A and 1099C simply reflect the amount the lender received for the sale of the property.
Considering the statement below:
For recourse loans, the amount of the realized gain is:
• the lesser of the debt immediately before the seizure reduced by any amount of the loan the debtor remains liable for after the seizure
• the FMV of the property at the time of the seizure.
In light of this, how important is it for you to have an accurate assessment of the client’s adjusted basis and the FMV of the property on the date of seizure rather then accepting the numbers the lender gives you?
How much money can you save your client with proper FMV documentation on the deemed sale of a foreclosed business building, especially since the gain would go on the Schedule C and be subject to SE tax?
For Example: My client has a business building used on a Schedule C that was foreclosed on in 2013. The 1099C shows a FMV of $200,000 and the outstanding loan was for $350,000, but I can document via real estate assessments, local realtor’s records, and recent sales of like-kind buildings in the area, that due to the economy bottoming out and the business district shutting down, the actual FMV of the building in question was $75,000. I just saved my client $75,000 of taxable income plus SE tax and the difference on the Form 4797 with a correct FMV. Do you think he’s happy with me?
Putting it all Together on the Tax Return
Once you have determined that there is possible CODI, you must determine where it goes on the tax return. After completing Form 982, which is attached to the return when filed, even if there is no actual CODI, you carry the CODI as follows:
Taxable CODI from a Form 1099C is usually reported on:
1. Form 1040 line 21 for personal use or investment income producing assets.
2. Form 1040 Schedule E for business assets of a rental activity.
3. Form 1040 Schedule C for business assets of a Schedule C business. (Subject to SE tax)
4. Form 1040 Schedule F for business assets of a farm. (Subject to SE tax)
And don’t forget, as we discussed earlier, when a piece of collateral is seized in place of a debt, it is deemed a sale of the property and must be reported like any other sale. This is treated as a separate transaction from the CODI calculation as you saw in the example earlier.
The reporting process and location on a foreclosure or repossession will vary determined by the type and use of the property that was seized. The lender should issue a Form 1099C for all unsecured or non-real property.
If the property is secured real property there may also be a Form 1099A issued showing the lender taking possession of the property before the debt is actually canceled and the Form 1099C is issued.
The most important information on the Form 1099A is included in Box 2, Box 4, and Box 5.
Box 2 indicates the amount of the outstanding loan. Box 4 indicates the lenders take on the FMV of the property (see the documentation discussion below), and Box 5 tells you whether the loan is recourse or non-recourse.
This reporting should be done in the year the debtor receives the Form 1099A or there is a provable transfer of interest in or abandonment of the property. This may or may not be the same year the debt is canceled.
The most important information on the Form 1099C is included in Box 2, Box 3, Box 5 and Box 7.
Box 2 indicates the amount of canceled debt, Box 3 indicates any interest included in Box 2, Box 5 indicates recourse or non-recourse loan, and Box 7 (which will usually only be completed if no 1099A is issued) indicates the lenders take on the FMV. On a 1099C this may be the actual sales price of the property.
This reporting should be done in the year the debt is actually canceled and/or the debtor receives a Form 1099C. If the debt is canceled in the same year as the property is transferred or sold the lender may only issue the Form 1099C as opposed to issuing both the 1099A and the 1099C. The debtor must still treat this as two separate transactions, a deemed sale and a CODI.