As we mentioned earlier, any time a property is seized or abandoned the owner has a “deemed sale” of that piece of property. As with any tangible asset, if there is a sale, there is a gain or loss. Whether or not that gain or loss is reportable and the manner in which it is reported will depend on the type and use of the property.
This is treated completely separately from the calculation of CODI and may occur in a separate tax year if the foreclosure takes an extended period of time. Unless both the seizure of the property and the cancellation of debt occur in the same tax year the debtor should receive a Form 1099A when title to the property is transferred to the lender who seizes it.
When the Form 1099A is received the debtor must make the calculations for the sale of that piece of property and report them on their tax return as required for any disposition of property.
The location the sale is reported will be determined by the use and type of the property. Some examples are:
1. Form 1040, Schedule D, personal use assets only if there is a gain. Losses are not reported but should be well documented for future reference.
2. Form 1040, Schedule D for investment use assets, normal capital gain or loss rules apply.
3. Form 4797 if a business asset is involved, and the results will flow to the Form 1040, Schedule C, D, E, or F depending on the use of the property.
Deemed sales are treated like any other sale of property for the purpose of exclusions (ie. §121 for gain on a primary residence) and recapture of credits and depreciation.
For Example: I purchased a primary residence in early 2009 and took the First Time Home Buyer Credit (FTHBC) of $7500, which I started repaying on my 2010 tax return. In 2013, I lost the house to foreclosure. The purchase price of the house was $150,000 and my adjusted basis (reduced by the credit) is $142,500. The Form 1099A shows a balance of $155,000 and the FMV on the date of foreclosure was $148,000. Using the worksheet below, see how we determine the possible CODI and possible taxable gain from these events.
As you can see I have the possibility of having $7,000 in CODI and $5,500 in gain on the deemed sale of my residence. However, this is just the first step in the calculation. We will discuss further steps for the CODI in the next section.
The gain on the sale of home would now be treated just like any other gain on the sale of your primary residence. Assuming I meet all of the qualifications for the §121 exclusion, and I do, I will put this sale on my Schedule D and then exclude the gain with the §121 indicator.
But we aren’t done with my tax situation yet. We still have to deal with the FTHBC. I have repaid $500 for the last three years. Now that the house is no longer my primary residence I must repay the remaining $6,000 on my 2013 tax return.
If the asset that was sold in a deemed sale was for business or rental use and has been depreciated then the depreciation recapture rules come into play when the Form 4797 is completed and the income is also carried to the appropriate locations on the tax return based on use and type.
Recourse debt versus non-recourse debt on a deemed sale is a tricky subject. You will see an example next under Foreclosures and in the case studies that will demonstrate why non-recourse debt may not always be the best way to go with a secured loan.