More about John and Reporting Foreclosures –
There is also a good possibility of John having income related to the Cancellation of Debt (CODI). This is a separate transaction and calculation from the gain or loss on the deemed sale of the property. See the worksheet below for a quick example of how the two transactions are separate, yet, related to each other. John purchased the car for $25,000. The FMV when seized was $10,000 and the outstanding loan balance was $22,000.
Worksheet for Foreclosures and Repossessions
Part 1. Figure income from cancellation of debt. (Note: If not personally liable for the debt, there is no income from cancellation of debt. Skip Part 1 and go to Part 2.
1. Enter the amount of debt canceled by the transfer of property 1) _$22,000_
2. Enter the fair market value of the transferred property 2) _$10,000_
3. Income from cancellation of debt. Subtract line 2 from line 1.
If less than zero, enter zero 3) _$12,000_
Part 2. Figure gain or loss from foreclosure or repossession.
4. Enter the smaller of line 1 or line 2. Also include any proceeds received from the foreclosure sale. (If not personally liable for the the debt, enter the amount of debt canceled by the transfer of property.) 4) _$10,000_
5. Enter the adjusted basis of the transferred property 5) _$25,000__
6. Gain of loss from foreclosure or repossession.
Subtract line 5 from line 4 6) ($15,000)
You can see that for the purpose of gain or loss from the deemed sale of the vehicle John has a loss of $15,000, which is non-deductible because it is personal use. But for the purpose of CODI, he has the possibility of taxable CODI of $12,000.
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.
The deemed sale from a Form 1099A is usually reported as follows:
1. Form 1040 Schedule D for personal use assets if there is a recognized 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.
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.
The CODI from Form 1099C is usually reported as follows:
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)
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.
Next week we pick up with the all important topic of Documentation.