1099-A for abandoned residence

Client walked away from home approx 8 years ago after divorce; filed bankruptcy 5 years ago which forced the loan to be non-recourse. He thinks he is home free...

In 2017 the bank finally foreclosed on the home. 1099-A was issued showing debt as non-recourse and outstanding balance of $260K with FMV of $210K.

It will be impossible to argue the FMV number; client paid $110K for the home and probably put over $100K into it but doesn't have receipts. Also the house is now a complete disaster after sitting so long with broken windows and no heat or electricity.

So, on 8949 we have a sale to report, at $260K realized since the loan is now non-recourse. Basis is $210K. Seems like there might be $50K of capital gain, here. There is not nor will there be any taxable debt forgiveness for this (non-recourse).

He has not lived in the house at all in the last 8 years. We are not sure if his ex-wife has lived in it...but very unlikely.

So...can he claim capital gains exclusion under § 121, according to the language in § 121(d)(3)(B):

(B) Property used by former spouse pursuant to divorce decree, etc.

Solely for purposes of this section, an individual shall be treated as using property as such individual’s principal residence during any period of ownership while such individual’s spouse or former spouse is granted use of the property under a divorce or separation instrument (as defined in section 71(b)(2)).

She was certainly "granted use of the property" by divorce decree. She might not have exercised that right, but this section of IRC doesn't say the spouse had to occupy the property. Right?

Am I on track here, or is there anything else I should be considering? It will be a real blow to this guy if he is hit with $50K of capital gain, so if there is a way to get the tax attributes legally away from that, I want to help him.

If client put that much money into the house, he had to pay it somehow. Perhaps with checks or credit cards. Copies of the statements could be obtained from the banks.

Reg. 1.121-4(b)(2) adds this language to the requirements.

... provided that the spouse or former spouse uses the property as his or her principal residence.

. So, unless she actually used the house as her principal residence, which you say is very unlikely, or that reg. is found to be invalid (highly unlikely, I think), your answer is no. The added language probably comes from the legislative history (Committee Reports) and/or the so-called Blue Book (General Explanation by the Joint Committee, or similar title). I have not looked. Even absent such a specific source, the reg. seems logical.

But you need to be clear on the facts, namely whether he was still the owner, whether she has lived in the house, and whether the divorce instrument granted her use of the property.

Thanks Cathy and Len. I knew I was on thin ice with that section of code

There is a slight chance she was technically in the house for the first two years of preceding five years, so I'll have to go get those facts and see.

I'll also revisit basis with him but I don't think it'll be there.

Client walked away from home approx 8 years ago after divorce; filed bankruptcy 5 years ago which forced the loan to be non-recourse. He thinks he is home free...

In 2017 the bank finally foreclosed on the home. 1099-A was issued showing debt as non-recourse and outstanding balance of $260K with FMV of $210K.

It will be impossible to argue the FMV number; client paid $110K for the home and probably put over $100K into it but doesn't have receipts.....

Fair market value of $210K as of what date? The date of the foreclosure? If so, that may not be the correct FMV for purposes of determining the amount realized on the foreclosure -- even if (because of the bankruptcy discharge) the debt is "nonrecourse."

What was the fair market value of the property immediately prior to the time of the taxpayer's bankruptcy discharge? I think an argument can be made that this would be the correct fair market value for purposes of determining how much of the principal of the debt (at the time of the discharge) was effectively converted to "nonrecourse" status. I would argue that increases (if any) in fair market value after the time of the bankruptcy discharge do not increase the "nonrecourse" debt amount.

Most of the lenders who foreclose after a bankruptcy have the wrong amount of debt on the 1099-A. The $260K is probably the same amount of debt that the client owed during the bankruptcy. If FMV at the time of bankruptcy was less than this amount, then some portion of the debt was canceled in bankruptcy. See PLR 8918016. For example, if the FMV at the time of the bankruptcy was $200K, then $60K was canceled by the bankruptcy, leaving $200K debt. If the FMV at the time of foreclosure was $210K, then there's no income to report.

Most of the lenders who foreclose after a bankruptcy have the wrong amount of debt on the 1099-A. The $260K is probably the same amount of debt that the client owed during the bankruptcy. If FMV at the time of bankruptcy was less than this amount, then some portion of the debt was canceled in bankruptcy. See PLR 8918016. For example, if the FMV at the time of the bankruptcy was $200K, then $60K was canceled by the bankruptcy, leaving $200K debt. If the FMV at the time of foreclosure was $210K, then there's no income to report.

Exactly.

Or, to use my example, the argument would be that the amount of nonrecourse debt is fixed, based on the FMV of the asset at the time of discharge. For this particular limited purpose, increases in FMV (after the time of discharge and up to the time of the eventual foreclosure) should not be counted in computing the taxpayer's foreclosure "amount realized".

thanks guys - so what do you do with the 1099-A if it has the debt amount wrong? I'd imagine the IRS is going to be looking for something on an 8949 for this "sales" transaction, and match up to that 1099-A (?)

thanks guys - so what do you do with the 1099-A if it has the debt amount wrong? I'd imagine the IRS is going to be looking for something on an 8949 for this "sales" transaction, and match up to that 1099-A (?)

I'd list the correct amount of debt on a Form 8275, explain the portion that was discharged in bankruptcy, and cite the PLR.

Will do, thanks. I was able to look up the bankruptcy from 2013, on Pacer. It had the FMV of the house at $186K and the loan at $256K, so a $70K unsecured differential. So we should be good on the absence of any further cap gain.

Appreciate all the help on this, I would never have known about that PLR .