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Cancellation of Debt, Foreclosures, And Bankruptcy – Part 4

Deemed Sales

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.

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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.

Next:  Part 5, The Procedural Flow of a Foreclosure.


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2 thoughts on “Cancellation of Debt, Foreclosures, And Bankruptcy – Part 4

  1. Great summary of the 1099A reporting requirements, Kathryn – just 2 comments for your kind feedback.

    (1) Your third tax reporting location for 1040 form mentions Sch C, D, E, or F for business assets but not sure this is what you meant. I would have thought you would have mentioned form 4797 and relevant calculated gain(loss) getting transferred to 1040 Pg 1 and/or form 8949 (Sch D). You proceed to address this later in your article (2nd to last paragraph) but just querying.

    (2) Recourse vs Nonrecourse discussion at end – thinking 1099-A box 5 dictates which tax law consequence is required depending on the legal nature of the underlying mortage. I must be missing something as you make it sound like taxpayer has choices for recourse vs nonrecourse.

    Thanks for getting this straightened out in my mind !

    • Avatar kathmorgan says:

      James, thanks for the read and the comments. In response to your questions: 1. In most cases, you are correct, the income from the 4797 will of course flow to the Sch D, which is included in the example, or to page 1 of the 1040 from the 4797. In very few cass, depending in the nature of the income from the sales it may flow back,to the C, E, or F as additional income. Mathis usually happens more in the case of COD rather then the deemed sales side of things. I will clarify that in my next rendition. Thanks for the help! No matter how many times you review a project this big you always miss something. 2. Once a loan is in place of course the taxpayer has no choice as to the recourse or non-recourse. You will see in the following part of the series why, even though non-recourse may seem a great choice for the taxpayer when making the loan, it can be disastrous for income tax reasons if the loan is actually defaulted. If you still have questions after the examples in the following sections, please follow up with me.

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