Free Trial: TheSiteFactory.com

Foreclosure gain/loss - Form 1099-A

Technical topics regarding tax preparation.
#1
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
Client wants to take the position that the following facts give rise to a foreclosure loss which should be treated as a deductible capital loss (limited to $3k annually). I think this may be the case but i would be grateful for a second opinion (or third…and any views to the contrary : )

Taxpayer received a 1099-A for 2018 with the following:

Box 1 - date: February 2018
Box 2 - principal balance: $600
Box 3 - blank 
Box 4 - fair market value: $1000
Box 5 - recourse debt: NOT checked

Taxpayer acquired the property as a personal residence in 2005 for $1100, taking out a mortgage loan for $900 (first mortgage) and a home equity line of credit for $100 ("HELOC") and supplying the balance as equity. 

Treating the foreclosure as a disposition, and ignoring the HELOC for a moment as this will be dealt with below, one would calculate the foreclosure loss as nonrecourse debt relief of $600 less basis of $1100 or $500. 

(1) Would you agree? 

But wait …there's more? Taxpayer rented the property to tenants during the years 2013 through 2015. 

In 2015, things started to unravel. Taxpayer filed for bankruptcy protection resulting in the discharge of the HELOC in its entirety (assume $100). In addition, the first mortgagee initialed the foreclosure proceedings that culminated in the issuance of the 1099-A. This debt not discharged in bankruptcy because it was nonrecourse debt to begin with. (Not sure why, but let's assume the taxpayer and "box 5" are right).

To calculate the foreclosure loss under the additional facts, we would need to take into account:

(i) attribute reduction (in effect basis reduction) under 108(b)(2)(E) as a result of the discharge of the HELOC in bankruptcy—subtract $100 from basis (reduce basis of all assets pro rata?), and

(ii) depreciation, allowed or allowable, as a result of the rental use of the property.

(2) Would you agree that the basis reduction should take into account depreciation “allowable” even if taxpayer took none?

(3) Would you agree that basis reduction should take into account depreciation for the period 2016 through 2018 during the period the property was in foreclosure even though the property was not actually rented during that time?

The recomputed basis for purposes of computing foreclosure loss therefore is $1100 original basis less $100 basis reduction under sec 108 less $70 further basis reduction by the depreciation allowed or allowable from 2013 to 2018, so $930.

(4) Does that sound right?

The foreclosure loss under the additional facts is nonrecourse debt relief of $600 less basis of $930 or $330. This is treated as a capital loss because the property was converted to rental use starting in 2013.

(5) Does THAT should right?

(6) And finally, just for fun, if you were to file an otherwise unremarkable 1040 that reflected the above positions and the TPT’s combined learning, would you charge extra?

Many thanks!
 

#2
dave829  
Posts:
495
Joined:
9-Jan-2018 9:28pm
Location:
California
Your premise is that no part of the 1st mortgage was discharged in bankruptcy. IRS would disagree. The portion of the mortgage that exceeds the FMV of the property was discharged in bankruptcy. See PLRs 8918016 and 8928012; Lewis, T.C. Memo. 1989-78. The secured portion of the debt that survives the bankruptcy is treated as a nonrecourse debt. PLR 8918016.

And I certainly wouldn’t rely on the 1099-A as evidence of the FMV, because banks often use the FMV from an appraisal in their file, which could be from the date of original purchase. Rather, look at the value stated in the 2015 bankruptcy petition and get the 2018 FMV from other sources, such as an appraiser, Zillow.com or a realtor.

David Fogel, who used to post on this board, has a good example in one of his articles. Suggest that you review it.
https://img1.wsimg.com/blobby/go/310b78 ... 511440.pdf
 

#3
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
Very thought provoking. Many thanks, Dave.

I think PLR 8918016 is distinguishable because the debt there was recourse to the taxpayer. My client maintains that he was not personally liable on the first mortgage debt. If you assume that's true for the sake of argument, how do you interpret the box 2 amount of $600? Is this the value of the collateral in early 2018? Or, is it really the value of principal? (I think your comment is based on an assumption that the debt was recourse and that the unsecured portion was discharged in bankruptcy; therefore, if I am interpreting your comment correctly, based on your assumption as to the facts the box 2 amount would represents only the unsecured portion rendered nonrecourse as a result of bankruptcy).

But, if the debt was really nonrecourse to start, there seems to be a problem.

That is, it seems to leave open the issue under Tufts of having to treat the entire amount of nonrecourse debt as an amount realized. (Again, not sure if I can interpret the Box 2 amount to be the amount realized? )

Anyway, very much appreciate your comments and the article. (Helpful examples on attribute reduction!)
 

#4
dave829  
Posts:
495
Joined:
9-Jan-2018 9:28pm
Location:
California
Diplodok wrote:My client maintains that he was not personally liable on the first mortgage debt.

I'd like to know how your client determined that. I see that you practice in Chicago. Mortgage loans in Illinois are generally RECOURSE.
 

#5
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
I hear you. I asked him twice. So, short of going over there and reading through the loan note myself I was going to go with what he told me ...and "going over there" you'll appreciate is not something we do lightly around here given that we ARE in Chicago and it's bloody cold out ;)
 

#6
dave829  
Posts:
495
Joined:
9-Jan-2018 9:28pm
Location:
California
That's why we have scanners and fax machines.

And if the mortgage was nonrecourse, wouldn't that strengthen the position that the portion in excess of FMV was discharged in bankruptcy (and not be a distinguishable fact)?
 

#7
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
And if the mortgage was nonrecourse, wouldn't that strengthen the position that the portion in excess of FMV was discharged in bankruptcy (and not be a distinguishable fact)?


Well, I assumed the answer was, "no," reasoning that if it's not a personal obligation, there is nothing to discharge. Recourse debt is discharged in bankruptcy to the extent it exceeds the value of the collateral. The consequences are then spelled out in the authorities you cited. Nonrecourse debt is the question.
 

#8
dave829  
Posts:
495
Joined:
9-Jan-2018 9:28pm
Location:
California
Diplodok wrote:I think PLR 8918016 is distinguishable because the debt there was recourse to the taxpayer.

PLR 8918016 doesn’t indicate whether the mortgage was recourse or nonrecourse. However, it does state that in the bankruptcy proceeding, the lender had a secured claim against the bankruptcy estate to the extent of the fair market value of the property (farm), and an unsecured claim to the extent the mortgage exceeded the fair market value of the farm, and that the bankruptcy discharge resulted in the elimination of the unsecured portion.
 

#9
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
Thanks, Dave. To close off on this I would summarize:

1.) I agree with you that a nonrecouse loan seems strange. I will follow up.
2.) If we do have nonrecourse debt though I think the approach about is correct. Seems we need to take Box 2 at face value. It's the principle amount of the debt per the lender. Under Tufts that's our amount realized in the foreclosure disposition and that's what the calc reflects.
3.) If it turns out that the debt was recourse then there may have been some additional discharge as a result of bankruptcy in 2015/2016 (and attendant attribute reduction) and the capital loss in the above calc is probably overstated.

As far as the PLR, you're right they don't use the term, but what they describe seems like recourse to me (taxpayer was personally liable).
 

#10
dave829  
Posts:
495
Joined:
9-Jan-2018 9:28pm
Location:
California
Diplodok, I disagree with you on 2) (and maybe 3)). If part of the debt was discharged in bankruptcy, then you must use the amount that was not discharged despite what the 1099-A says. You also need to find out the FMV at time of bankruptcy discharge and at time of foreclosure.

I still don't see that it makes any difference whether the mortgage was recourse or nonrecourse. The following might convince you of this:

https://www.hainesandkrieger.com/non-re ... ankruptcy/

In Re Reed, Case No. 16-18947-JGR (B.C. Colo. 2017)
http://www.cob.uscourts.gov/sites/defau ... 947jgr.pdf
 

#11
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
Dave,

I think were we may not be on the same page is that I'm guessing you would disagree with the following statement:

A debtor who borrows on a nonrecourse basis cannot avail himself of bankruptcy because the debt is not a dischargeable debt.
 

#12
dave829  
Posts:
495
Joined:
9-Jan-2018 9:28pm
Location:
California
Diplodok, you don't provide the source for this statement, and it's not in either of the two links or the cites I sent you. So, since you're a tax attorney, I see that you're simply going to argue your position forever. It makes no sense for me to continue this discussion.
 

#13
Posts:
26
Joined:
3-Feb-2019 3:12pm
Location:
Chicago
Gosh, Dave, I was trying to find some common ground. You've said before you disagree with me so here, I was attempting to get to the root of the difference of our opinion. It's not a trick question. And, I'm not trying to argue the point or convince you of it. I'm resigned to let reasonable minds differ. I for one would in fact agree with that statement. That is, nonrecourse debts do not get discharged in bankruptcy. To me that's a pretty uncontroversial statement. If you do not agree with that, so be it. All I'm saying is, this fundamental difference of opinion I think has the follow on consequences that we simply then analyze the bankruptcy and foreclosure events differently.
 


Return to Taxation



Who is online

Users browsing this forum: Google [Bot] and 24 guests