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1099-C and QRPBI Exclusion - reality check

Technical topics regarding tax preparation.
#1
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The taxpayer received a 1099-C for 88K in tax year 2014 for a rental property purchased in 1995 and refinanced in 2008. He was NOT insolvent so I looked at applying the "Qualified Real Property Business Indebtedness" exclusion. Per my reading of Sec 108 and use of Pub 4681, I did NOT exclude any of the COD income on the return as I determined none qualified for the exclusion. The client has hired a new CPA that says I should have made the election and has calculated the Adjusted basis of the property as the amount that should have been excluded under QRPBI. The new CPA likely does not have access to the same info I did, and the taxpayer likely told him all the debt was "for the rental" and he is just taking his word for it.

I am looking for a reality check here to be sure I did not mess this up. I've been thru it over and over and over and I don't think I did.

Facts:
1 - Debt cancelled was for 88K (1099-C issued), AND taxpayer RETAINED the property. This bank just walked away and gave him clear title.

2 - Original note for purchase of rental in 1995 was 54K

3 - Note was refinanced in 2008 for 77K. Of which approx 43K was the original balance of the mortgage, the rest was 10K credit card debt, a few small other debts and cash out to the taxpayer of approx 13K

4 - Taxpayer could not prove any of the credit card debt was used to improve the property, and I knew none of the cash out was either as I did the returns from 2008 thru 2015. Nothing went on the depreciation schedule and there were no major improvements in his expenses.

5 - taxpayer stopped paying on the loan in 2012. Balance rose to 88K likely due to interest not paid and probably some property taxes the lender paid. We did not get clear information on the amount from the lender.

6 - total basis in the property is 69000 of which 7500 of the house is allocated to land.

7 - total accum deprec is 42,000 (obviously using round numbers to make this easy)


My analysis:

1 - The 43K remaining original mortgage balance was the only "qualified acquisition indebtedness" as defined in 108(c)(4).

2 - The FMV of the property was 65K and I used the local tax assessment for that determination. I could get behind it being worth a bit less as it was not in great shape, but the taxpayer was not going to do an appraisal.

3 - QRPBI has 2 limits for determining exclusion. The first is the outstanding principle amount of the qualified real property business debt over the FMV just before cancellation. So since 43K is lower than 65K, I ended it there and said that none of the COD income was excludable. The second limit is an overall limit that looks at the adjusted basis in the property. Since I did not pass the first limit, I did not go to the overall limit.



Does anyone see anything I may have misunderstood or looked at wrongly??

Even if the total amount of the REFI could be proven to be qualified debt, wouldn't we still have 77K vs 65K and the COD exclusion would have bee 12K?? Then we could look to the overall limit to be sure we did not have to limit it FURTHER?? CPA is using 69000-42000 and saying 27000 should have been excluded.

I see all these COD exclusions as helping taxpayers who are legitimately "under water" on an asset. Am I missing a principle here?

Thanks in advance for any responses. And yes, I have contacted my E & O insurer.
 

#2
dave829  
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Your analysis looks right. The new CPA is likely missing the limitation on the exclusion as provided in 108(c)(2)(A).
 

#3
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dave829 wrote:Your analysis looks right. The new CPA is likely missing the limitation on the exclusion as provided in 108(c)(2)(A).


Thanks Dave.....

Yes, that is what he has to be doing. And I believe he is doing so because the taxpayer is telling him the entire debt is for the rental. It was indeed secured by the rental, but that does not make it automatically qualified for exclusion. I do know the CPA realizes there was a refinance in there. I guess he has no due diligence requirements to confirm the details.

If the new CPA looked at the 2014 documents there was a "satisfaction of Mortgage" stmt in the packet I gave back to taxpayer. It clearly had the note balance as 77k so at the very least the new guy should be wondering how it got to be 88K.
 

#4
dave829  
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kbairtax, if $11K of accrued interest and/or taxes were added to the balance of the debt, then there should be no COD income for these items if they would have been deductible had they been paid by the client. See 108(e)(2).
 

#5
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dave829 wrote:kbairtax, if $11K of accrued interest and/or taxes were added to the balance of the debt, then there should be no COD income for these items if they would have been deductible had they been paid by the client. See 108(e)(2).


Yup, thanks for confirming that as well....just another point that the new CPA is overlooking. But then again, I am sure he does not have the same information that I had and the taxpayer was likely not forthcoming. I ditched the client for a reason! :shock:

I know we can rely on our clients answers for some things, but when it comes to something like this I would think the due diligence would need to be more substantial. I did mine, but then again sometimes I dig more than I need to.....or in some cases should! ;)
 


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