Introduction to the Federal Income Tax Issues Concerning Cancellation of Debt and the Reporting Required When a Taxpayer Receives Form 1099-A and Form 1099-C

Written and Presented by

Paul LaMonaca, CPA, MST

Seminar materials and seminar presentations are intended to stimulate thought and discussion and to provide attendees with useful ideas and guidance in the areas of federal taxation and administration. These materials as well as the comments of the instructors do not constitute and should not be treated as tax advice regarding the use of any particular tax procedure, tax planning technique or device or suggestion or any of the tax consequences associated with them. Although the author has made every effort to ensure the accuracy of the materials and the seminar presentation, neither the author, the presenter nor the National Society of Tax Professionals assumes any responsibility for any individual’s reliance on the written or oral information presented during the presentation. Each attendee should verify independently all statements made in the materials and during the seminar presentation before applying them to a particular fact pattern and should determine independently the tax and other consequences of using any particular device, technique or suggestion before recommending the same to a client or implementing the same on a client’s or on his or her own behalf.

Copyright © Paul LaMonaca 2015. All Rights Reserved. Materials may not be copied or reprinted without prior written permission of Paul LaMonaca.

Table of Contents Page A.

Comparison of IRS Forms 1099-A and 1099-C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B.

Instructions for Form 1099-A “Acquisition or Abandonment of Secured Property” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

C.

Instructions for Form 1099-C “Cancellation of Debt” . . . . . . . . . . . . . . . . . . . . . . . . . . 2

D.

Abandonment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

E.

Specific Instructions for Form 1099-C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

F.

Debt Defined and When is it Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

G.

§61(a)(12) and §108 Discharge of Indebtedness Issues . . . . . . . . . . . . . . . . . . . . . . . . . 8

H.

Home Mortgage Debt Relief Expired After 12/31/2014 . . . . . . . . . . . . . . . . . . . . . . . . 11

Supplemental Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 •

Tax Court Case: Taxpayer Liable for Cancellation of Debt Even Though 1099-C Reports Otherwise

•

IRS Form 1099-A Acquisition or Abandonment of Secured Property and Instructions

•

IRS Form 1099-C Cancellation of Debt and Instructions

•

IRS Publication 4681 Cancelled Debts, Foreclosures, Repossessions and Abandonments (for Individuals)

Recommended IRS Publications: •

544 Sales and Other Dispositions of Assets

•

551 Basis of Assets

•

908 Bankruptcy Tax Guide

•

982 Reduction of Tax Attributes Due to Discharge of Indebtedness (And Section 1082 Basis Adjustment)

A.

B.

Comparison of IRS Forms 1099-A and 1099-C 1.

There is much confusion over the reporting requirements concerning the issuing and receiving of IRS Form 1099-A “Acquisition or Abandonment of Secured Property” and IRS Form 1099-C “Cancellation of Debt.” The information reported on these two forms are very similar and there is where the confusion begins.

2.

On Form 1099-A, the LENDER is required to report their identifying information such as name, street address, city, state, zip code and telephone number and foreign postal code if applicable along with their federal identification number. In addition, the Form 1099-A requires the BORROWER’S identification number as well as the other identifying information which includes the name, street address, city, state, zip code or foreign postal code as well as the account number of the BORROWER.

3.

On the Form 1099-C the CREDITOR’S name, address and federal identification number is required as is all of the identifying information about the DEBTOR, including identification number, name, address etc. and the account number.

Instructions for Form 1099-A “Acquisition or Abandonment of Secured Property” 1.

Form 1099-A, Box 1 is titled “Date of lender’s acquisition or knowledge of abandonment.” Therefore it reports a lender’s acquisition of property that was security for a loan and the date is generally the earlier of: a.

the date title was transferred to the lender, or

b.

the date possession and the burdens and benefits of ownership were transferred to the lender.

Tax Professional Note: This date may be the date of the foreclosure or execution sale or the date the taxpayer’s right of redemption or objection expired. 2.

If the taxpayer abandoned the property then the date shown is the date on which the lender first knew or had reason to know that the property was abandoned or the date of foreclosure, execution, or similar sale.

3.

Form 1099-A, Box 2 reports “Balance of Principal Outstanding” which is the debt owed to the lender on the loan when: 1

a.

the interest in the property was acquired by the lender or

b.

on the date the lender first knew or had reason to know that the property was abandoned.

4.

Box 3 of Form 1099-A is blank.

5.

Box 4 reports the “Fair Market Value of the Property” (FMV). If the FMV amount in Box 4 is less than the “Balance of Principal Outstanding” in Box 2 and the debt is actually cancelled, then the taxpayer may have cancellation of debt income. Tax Professional Note: The instructions for Box 4 of Form 1099-A state that if the property of issue is the taxpayer’s principal residence then IRS Publication 523 “Selling Your Home” should be reviewed in order to determine any taxable gain or ordinary income on the foreclosure or abandonment. (There are issues concerning the exclusion of gain under the provisions of §121.)

C.

6.

Box 5 requires that the LENDER check the box if the BORROWER was personally liable for repayment of the debt when the debt was created or, if modified after the creation when it was last modified.

7.

Box 6 reports the “Description of the Property” acquired by the LENDER or abandoned by the BORROWER.

Instructions for Form 1099-C “Cancellation of Debt” 1.

Form 1099-C requires that the CREDITOR’S name, street address, etc. including telephone number be included as well as the CREDITOR’S federal identification number. It also includes the DEBTOR’S identification number, name, street address, etc. The CREDITOR also is required to report an account number or other unique number assigned to distinguish the DEBTOR’S account.

2.

The general instructions on Form 1099-C state that the DEBTOR receives the document because a Federal Government agency or an applicable financial entity (CREDITOR) has discharged (either through cancellation or forgiveness) a debt that the DEBTOR owed or because an identifiable event occurred that either is or is deemed to be a discharge of a debt of $600 or more.

2

Tax Professional Note: If a CREDITOR has discharged a debt that the taxpayer owed, then the taxpayer is required to include the discharged amount in gross income even if less than $600 on the “Other Income” line of Form 1040. 3.

The instructions further state that the taxpayer may not have to include all of the cancelled debt in income if they qualify for any of the exceptions and exclusions under the law for situations such as bankruptcy and insolvency in which the instructions refer the taxpayer to IRS Publication 4681, “Cancelled Debts, Foreclosures, Repossessions and Abandonments.”

4.

In addition, the instructions state that if an identifiable event has occurred but the debt has not actually been discharged then the taxpayer should include any discharged debt in income in the year that it is actually discharged unless an exception or exclusion applies in that tax year.

5.

Box 1 reports the date the earliest identifiable event occurred, or at the CREDITOR’S discretion, the date of an actual discharge that occurred before an identifiable event. The instruction refers the taxpayer to an “event code” in Box 6 of Form 1099-C which is discussed later under the information for Box 6.

6.

Box 2 reports the “amount of debt discharged” which is the amount of debt either actually or deemed discharged. The instructions provide a note to the taxpayer which states if the taxpayer does not agree with the amount, then they should contact the CREDITOR.

7.

Box 3 reports “interest if included in Box 2.” This amount may or may not have to be reported in gross income and will be discussed later.

8.

Box 4 reports “debt description” and states that if Box 7 (Fair Market Value of Property) is completed then Box 4 also reports a description of the property.

9.

Box 5 reports “If checked, the DEBTOR was personally liable for the repayment of the debt.” This box would be checked if the taxpayer was personably liable for the debt when the debt was created or, if modified, at the time of the last modification and refers to IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions and Abandonments.

10.

Box 6 reports an “Identifiable Event Code” mentioned n Box 1 above. It is the reason the CREDITOR filed the form. The codes in Box 6 are described in more detail in Pub. 4681. The Codes are as follows:

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A B C D E F G H I

-

Bankruptcy; Other judicial debt relief; Statute of limitations expiration of deficiency period; Foreclosure election; Debt relief from probable or similar proceedings; By agreement; Decision or policy to discontinue collection; Expiration of nonpayment testing period, or Other actual discharge before identifiable event.

11.

Box 7 reports “Fair market value of property” (FMV). If, in the same calendar year, a foreclosure or abandonment of property occurred in connection with the cancellation of the debt then the FMV of the property will be shown, or the taxpayer will receive a separate Form 1099-A. Generally, the gross foreclosure bid price is considered to be the FMV.

12.

For an abandonment or voluntary conveyance in lieu of foreclosure, the FMV is generally the appraised value of the property. The taxpayer may have income or loss due to the acquisition of the property by the LENDER or the abandonment of the property by the BORROWER.

13.

The IRS instructions for Forms 1099-A and 1099-C are included in the same physical document. The specific instructions for Form 1099-A state that the issuer should file the form for each BORROWER if:

14.

a.

the issuer lends money in connection with their trade or business and,

b.

in full or partial satisfaction of the debt, the issuer acquires an interest in property that is security for the debt, or has reason to know that the property has been abandoned.

•

It further states that the issuer need not be in the business of lending money to be subject to this reporting requirement.

The instructions also introduce the issue of coordination with Form 1099-C and states that if, in the same calendar year, the issuer cancels a debt of $600 or more in connection with a foreclosure or abandonment of secured property, then it is not necessary to file both Form 1099-A and Form 1099-C. The instructions state that the issuer may file Form 1099-C only and states that the issuer will meet their 1099-A filing requirement for the debtor by completing Boxes 4, 5 and 7 on Form 1099-C. It also states that if the issuer files both Forms 1099-A and 1099-C then they do not complete Boxes 4, 5 or 7 on Form 1099-C. 4

15.

D.

According to the instructions for Form 1099-A, “property” is defined as meaning any: a.

real property (such as a personal residence),

b.

intangible property, and

c.

personal property.

16.

However, the instructions state that there are reporting exceptions and no reporting is required for tangible personal property (such as a car) held only for personal use. However, the lender is required to file the Form 1099-A if the property is totally or partially held for use in a trade or business or for investment.

17.

Also, no reporting is required if the property that is securing the loan is located outside the United States and the borrower has furnished the lender a statement, under penalties of perjury, that the borrower is an exempt foreign person (unless the lender knows the statement is false).

Abandonment 1.

The instructions for Form 1099-A also discuss the issues dealing with an abandonment of a property. An abandonment occurs when the objective facts and circumstances indicate that the borrower intended to an has permanently discarded the property from use.

2.

The lender has “reason to know” of an abandonment based on all the facts and circumstances concerning the status of the property. The lender will be deemed to know all the information that would have been discovered through a reasonable inquiry when, in the ordinary course of business the lender becomes aware or should become aware of circumstances indicating that the property has been abandoned.

3.

If the lender expects to commence a foreclosure execution, or similar sale within 3 months of the date and had reason to know that the property was abandoned, then reporting is required as of the date the lender acquires an interest in the property or a third party purchases the property at such sale. If the lender expects to but does not commence such action within 3 months, then the reporting requirement arises at the end of the 3-month period.

5

E.

Specific Instructions for Form 1099-C 1.

The issuer of a 1099-C is required to file the form for each debtor for whom the issuer cancelled a debt owed to them of $600 or more if they are a specific entity listed in the instructions and an identifiable event has occurred. It does not matter whether the actual cancellation is on or before the date of the identifiable event. Tax Professional Note: The instructions state that the Form 1099-C must be filed regardless of whether the debtor is required to report the debt as income. The debtor may be an individual, corporation, trust, estate, association or company.

F.

2.

The instructions discuss the coordination with Form 1099-A and state that if in the same calendar year, the creditor cancels a debt of $600 or more in connection with a foreclosure or abandonment of secured property then it is not necessary to file both forms to the same debtor.

3.

The instructions also state that the creditor can file just the Form 1099-C and that they will meet the Form 1099-A filing requirement for the debtor by completing Boxes 4, 5 and 7 on Form 1099-C. The creditor may file both but should not complete Box 4, 5 and 7 on Form 1099-C.

Debt Defined and When is it Cancelled 1.

A debt is any amount owed including stated principal, stated interest, fees, penalties, administrative costs and fines. The amount of debt cancelled may be all or only part of the total amount owed. However, for a lending transaction, the creditor required to report only the stated principal.

2.

A debt is deemed cancelled on the date an identifiable event occurs, or, if earlier, the date of the actual discharge if the creditor chooses to file Form 1099-C for the year of cancellation. An identifiable event is one of the following: a.

A discharge in bankruptcy under Tile 11 of the U.S. Code. There are certain discharges in bankruptcy not required to be reported described under Exception in the instructions of Form 1099-C. Enter “A” in Box 6 to report this identifiable event.

b.

A cancellation or extinguishment making the debt unenforceable in a receivership, foreclosure or similar federal nonbankruptcy or state court proceeding. Enter “B” in Box 6 to report this identifiable event. 6

c.

A cancellation or extinguishment when the statute of limitations for collecting the debt expires, or when the statutory period for filing a claim or beginning a deficiency judgment proceeding expires. Expiration of the statute of limitations is an identifiable event only when a debtor’s affirmative statute of limitations defense is upheld in a final judgment or decision of a court and the appeal period has expired. Enter “C” in Box 6 to report this identifiable event.

d.

A cancellation or extinguishment when the creditor elects foreclosure remedies that by law extinguish or bar the creditor’s right to collect the debt. This event applies to a mortgage lender or holder who is barred by local law from pursuing debt collection after a “power of sale” in the mortgage or deed of trust is exercised. Enter “D” in Box 6 to report this identifiable event.

e.

A cancellation or extinguishment making the debt unenforceable under a probate or similar proceeding. Enter “E” in Box 6 to report this identifiable event.

f.

A discharge of indebtedness under an agreement between the creditor and the debtor to cancel the debt at less than full consideration (for example, short sales). Enter “F” in Box 6 to report this identifiable event.

g.

A discharge of indebtedness because of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. A creditor’s defined policy can be in writing or an established business practice of the creditor. A creditor’s established practice to stop collection activity and abandon a debt when a particular nonpayment period expires is a defined policy. Enter “G” in Box 6 to report this identifiable event.

h.

The expiration of non-payment testing period discussed in the Form 1099-C instructions. This event occurs when the creditor has not received a payment on the debt during the testing period. The testing period is a 36-month period ending on December 31, plus any time when the creditor was precluded from collection activity by a stay in bankruptcy or similar bar under state or local law. Enter “H” in Box 6 to report this identifiable event. Tax Professional Note: The creditor can rebut the occurrence of this identifiable event if:

7

(a)

the creditor (or a third party collection agency on behalf of the creditor) has engaged in significant bona fide collection activity during the 12-month period ending on December 31, or

(b)

Facts and circumstances that exist on January 31 following the end of the 36-month period indicate that the debt was not cancelled.

Significant bona fide collection activity does not include nominal or ministerial collection action, such as an automated mailing. Facts and circumstances indicating that a debt was not cancelled include the existence of a lien relating to the debt (up to the value of the security) or the sale or packaging for sale of the debt by the creditor. i.

G.

Other actual discharge before identifiable event. Enter “I" in Box 6 if there is another actual discharge before one of the identifiable events listed above.

§61(a)(12) and §108 Discharge of Indebtedness Issues 1.

§61(a) provides a general rule that gross income means all income from whatever source derived unless there is a specific exception, exemption or exclusion. Specifically, §61(a)(12) provides in general that gross income includes income from the discharge of indebtedness, and §108 discusses the specifics of “income from discharge of indebtedness.”

2.

For purposes of this discussion §108(a)(1) provides that gross income does not include any amount of the indebtedness if the taxpayer is:

3.

a.

bankrupt under a Title 11 case,

b.

the discharge takes place when the taxpayer is insolvent,

c.

the indebtedness discharged is qualified farm indebtedness,

d.

the indebtedness is qualified real property business indebtedness, or

e.

the debt is qualified principal residence indebtedness.

Publication 4681: Cancelled Debts, Foreclosures, Repossessions and Abandonments addresses how to report the forgiveness of debt and how and when the §108(a)(1) exceptions to inclusion to gross income are permitted. Part 3 of Publication 4681 addresses “Abandonments.” This section discusses the tax consequences of abandoning property subject to tax. 8

4.

Generally when there is forgiveness of debt for $600 or more the entity that forgives the debt should issue IRS Form 1099-C Cancellation of Debt and the amount of debt is reported in Box 2. Unless the taxpayer meets an exception or exclusion, the cancelled debt is ordinary income includible in the current year’s tax return. Tax Professional Reminder: Even if the taxpayer did not receive a Form 1099-C the cancelled debt must be reported as gross income in the current year unless one of the exceptions or exclusions to the general inclusion rule applies.

5.

In the situations where a IRS Form 1099-C is not issued to the taxpayer, there is still debt forgiveness which must be reported. In many cases an IRS Form 1099-A Acquisition or Abandonment of Secured Property is issued and IRS Form 1099-C is never issued. In this situation there has been debt forgiveness and it must be reported. The reporting depends on whether or not the debt forgiven is recourse or nonrecourse.

6.

Recourse debt is defined as debt for which the taxpayer is personally liable even if the proceeds from the disposition of the property are not enough to satisfy the amount owed.

7.

Nonrecourse debt is defined as debt for which taxpayer is not personally liable beyond the amount realized on the disposition of the property. If the taxpayer is not personally liable for the debt then there is no ordinary income from the cancellation of the debt unless the taxpayer retains the property and either: a.

the lender offers a discount for early payment of the debt, or

b.

the lender agrees to a loan modification that results in the reduction of the principal balance of the debt.

EXAMPLE #1: Don owned a rental property that had a cost basis of $395,571 and accumulated depreciation of $83,297 resulting in an adjusted basis of $312,274. The property was foreclosed and repossessed and the creditor issued IRS Form 1099C. The bank stated that the Box 1 date of the creditor’s identifiable event was 8/10/15 and the Box 2 Amount of Debt Discharged was $163,214. The outstanding debt immediately before the foreclosure was $478,401. The Box 4 Fair Market Value was $315,187 which was the price for which it was sold by the bank. Box 5 reported that Don was personally liable for repayment of the debt, therefore his debt is recourse debt. The abandonment or foreclosure is a deemed sale of the property requiring Don to report a disposition on IRS Form 4797.

9

Don must first determine his ordinary income as follows: Outstanding Debt Before the Transfer Less: FMV of Property Transferred (Box 4) Ordinary Income from the Cancellation of Debt (Box 2)

$478,401 (315,187) $163,214

Don must then calculate any gain or loss on the foreclosure or repossession as follows: Fair Market Value (Box 4)

$315,187

Less: Adjusted Basis of Property

(312,274)

Gain or Loss on Foreclosure or Repossession

$

2,446

As a result Don has two separate transactions with the first resulting in ordinary income of $163,214 and the second resulting in a capital gain of $2,446. The recognition of the capital gain will generate §1250 unrecaptured depreciation subject to a maximum long-term capital gain rate of 25%. The ordinary income is required to be reported on Schedule E as rental income. However, Don may be able to exclude some or all of the ordinary income by reviewing IRS Form 982 to see if he satisfies any of the exceptions or exclusions under §108(a)(1). EXAMPLE #2: Don owned a rental property with a cost of $75,000 and accumulated depreciation of $60,000 resulting in an adjusted basis of $15,000. The property was foreclosed and repossessed and the lender issued IRS Form 1099-A. The Box 1 date was 8/10/15 and the Box 2 Balance of Principal Outstanding was $147,029 and the Box 4 FMV was $62,000. Box 5 reported that Don was not personally liable for the repayment of the debt meaning that the debt was nonrecourse debt. When reviewing Table 1-1 in IRS Publication 4681, Part I, the ordinary income calculation is not required to be completed if the taxpayer is not personally liable for the debt. Therefore, Don is only required to calculate the gain or loss on the foreclosure and repossession where he is required to report the amount of outstanding debt from Box 2. He calculates a gain as follows: Outstanding Debt (Amount Realized) Less: Adjusted Basis Gain on Foreclosure or Repossession 10

$147,029 ( 15,000) $132,029

The transaction is reported o IRS Form 4797, Page 2, Part III. Don will include $60,000 of the $132,029 as §1250 Unrecaptured Depreciation subject to a maximum capital gain rate of 25% and the balance will be the appreciation includible as a long term capital gain with a maximum rate of 15% or 20% depending on his ordinary tax bracket threshold amount. H.

Home Mortgage Debt Relief Scheduled to Expire After 12/31/2016 1.

§108(a)(1)(E) provides that principal residence debt discharged on or after January 1, 2007 and before January 1, 2017, is excluded from gross income.

2.

The law provides that gross income does not include any discharge of qualified principal residence indebtedness. A taxpayer can exclude up to $2 million of mortgage debt forgiveness on their principal residence. Tax Professional Note: The Committee report states that this exclusion applies whether there is a restructure of debt or the taxpayer loses the residence in a foreclosure. EXAMPLE #1: Before the 2007 Mortgage Relief Act, there were no special rules applicable to discharge of indebtedness of acquisition debt on a taxpayer’s principal residence, Don was not in bankruptcy and was not insolvent and had a property subject to a $200,000 mortgage debt for which he was personal liability. The creditor foreclosed and the home was sold for $180,000 in satisfaction of the debt. As a result Don had $20,000 of discharge of indebtedness which was included in ordinary income. The result would have been the same if the creditor had also restructured the loan and reduced the debt to $180,000. EXAMPLE #2: As a result of the 2007 Mortgage Relief Act Don does not have to include the $20,000 in income because of the exclusion rule. The result would be the same whether the creditor restructures the loan and reduces the principal amount to $180,000 or forecloses on the property and satisfies the $200,000 debt with a $180,000 transaction.

3.

§108(h)(4) provides that if any loan is discharged, in whole or in part, and only part of the loan is qualified principal residence indebtedness, then the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before the discharge) which is not qualified principal residence indebtedness. 11

EXAMPLE #3: Don’s principal residence is secured by a debt of $600,000, of which $400,000 is qualified principal residence indebtedness. If Don’s residence is sold for $300,000 and $300,000 of debt is discharged, only $100,000 of the debt discharged may be excluded as follows:

Total Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $600,000 Qualified Principal Residence Debt . . . . . . . . . . . . . . . . . (400,000) Nonqualified Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $200,000 Total Debt Forgiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . (300,000) Exclusion for Home Mortgage Debt Relief . . . . . . . . . . . $(100,000)

The remaining $200,000 of nonqualified debt may qualify in whole or in part for one of the other exclusions (e.g., the insolvency exclusion). Don must report the transaction on IRS Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustments). Don will also be issued IRS Form 1099-C Cancellation of Debt by the Creditor by no later than January 31 following the year of debt forgiveness. 4.

§108(h)(2) provides that qualified principal residence indebtedness is acquisition indebtedness under §163(h)(3)(B) with respect to the taxpayer’s principal residence, with a $2 million limit ($1 million for married individuals filing separately).

5.

§108(h)(5) provides that “principal residence” has the same meaning as under the home sale exclusion rules of §121. Tax Professional Reminder: Acquisition indebtedness of a principal residence is indebtedness incurred in the acquisition, construction, or substantial improvement of an individuals’ principal residence that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing does not exceed the amount of the refinanced indebtedness. (Joint Committee on Taxation JCX-86-07)

12

6.

§108(h)(1) provides that the basis of the taxpayer’s principal residence is reduced by the excluded amount, but not below zero. TAX PROFESSIONAL ALERT: The mortgage forgiveness exclusion only applies with respect to a taxpayer’s principal residence only. Therefore, while interest for a taxpayer’s second home may be deductible, debt forgiven with respect to a taxpayer’s second home is not excludible.

7.

§108(a)(2) provides that an insolvent taxpayer (other than one in a Title 11 bankruptcy) can elect to have the mortgage forgiveness exclusion not apply and can instead rely on the §108(a)(1)(B) exclusion for insolvent taxpayers.

8.

If there is a gain on the foreclosure of a principal residence then it may be partially or completely excluded from gross income under the provisions of §121.

9.

If the taxpayer did not qualify for the 2-out-of-5 year ownership and use test then one could still qualify for the partial exclusion due to a change in employment, health or “unforeseen circumstances.” Reg. §1.121-3 states that safe-harbor events such as an involuntary conversion, job loss, and events identified by the IRS as “unforeseen circumstances.”

10.

The law requires that IRS Form 982 be attached to the taxpayer’s return if any debt forgiven is excluded from income.

11.

Most taxpayers who are affected by this exclusion rule will be required to fill out only a few lines on Form 982. In Part I under General Information a taxpayer will: a.

check box 1(e) which is Discharge of Qualified Principal Residence Indebtedness,

b.

enter on line 2 total amount of discharged indebtedness excluded from gross income, and

c.

enter on line 10b the amount applied to reduce the basis of the principal residence.

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12.

The instructions in Form 982 alert taxpayers that debt discharge under Title 11 bankruptcy cannot be treated as a discharge of qualified residence indebtedness and should follow the instructions for nonbusiness debt and check box 1a. Also, if the taxpayer is insolvent then the taxpayer can elect to follow the insolvency rules and check box 1b and follow the Form 982 instructions for a nonbusiness debt.

13.

Lenders are required to issue IRS Form 1099-C by January 31 following the year of debt forgiveness for taxpayers whose debt was reduced or eliminated.

14.

The Form 1099-C must report the amount of debt forgiven and the fair market value (FMV) of any property given up through foreclosure. The IRS states that the taxpayers review the form carefully and notify the lender immediately if any of the information reported is incorrect and cautions that special attention should be paid to the amount of debt forgiven in Box 2 and the FMV in Box 7.

15.

The most difficult issue that the taxpayer faces is the FMV at the time the debt is discharged. Generally FMV is the price at which the property is sold or if no sale takes place, a willing buyer and willing seller would agree to a given price where neither is under any pressure to buy or sell and are aware of all the facts surrounding the condition of the property.

16.

In a situation where the taxpayer has to surrender the property to the creditor in an exchange for a cancellation of debt, the taxpayer may not agree with the FMV reported on the Form 1099-C. In this circumstance if the taxpayer could afford a professional appraisal of the property prior to the transfer of the property then this may be a better course of action in order to determine the proper FMV. Tax Professional Research Recommendation: IRS Publication 4681 Cancelled Debts, Foreclosures Repossessions and Abandonments.

14

Supplemental Materials

15

Taxpayer Liable for Cancellation of Debt Even Though 1099-C Reports Otherwise Donald L. Dunnigan v. Commissioner, T.C. Memo 2015-190 §61 and §108 (9/28/2015) Summary of the Case: A taxpayer operated an appraisal business (Dunnigan Appraisal) as a sole proprietorship and obtained a line of credit for it from Swift Financial. The Swift agreement provided that Dunnigan was liable for the debt both individually and on behalf of Dunnigan Appraisal. In 2009, after receiving about $50,000 from the line of credit, Dunnigan negotiated with Swift to settle the debt for $15,628. Swift filed a Form 1099-C (Cancellation of Debt) reporting Cancellation of Debt (COD) income of $34,369.24 and indicating (in Box 5) that Dunnigan was not personally liable for the debt. As a result Dunnigan did not report the COD income on his 2009 return, but provided a note explaining that the COD was not taxable because, as indicated on the Form 1099-C, Swift was not holding him personally liable for the debt. The Tax Court disagreed. In direct opposition to the Form 1099-C, the Swift agreement provided that Dunnigan was individually liable for the debt, therefore, he had COD income. NOTE: Dunnigan represented himself in Tax Court, (Pro se). Details of Case: 1.

Petitioner was an appraiser and the sole proprietor of Donald Dunnigan Period House Appraisal (Dunnigan Appraisal). In 2008 Dunnigan Appraisal was in need of cashflow, and obtained a business line of credit for $50,000 from Swift with respect to Dunnigan Appraisal.

2.

The credit agreement that Swift drafted for Dunnigan Appraisal provided that both parties were jointly and severally liable to pay all loans and all other debts, obligations and liabilities of every kind and description, arising out of all account transactions authorized by Dunnigan.

3.

Over time he received approximately $50,000 from the Swift line of credit, which he used to pay obligations of Dunnigan Appraisal. In 2009 he was unable to pay back the borrowed funds in full, and he negotiated with Swift to pay $15,628 in settlement of the debt Swift later reported on Form 1099-C, Cancellation of Debt, that it had cancelled the debt of $34,369.24 on September 28, 2009. It further indicated in Box 5 of Form 1099-C that Dunnigan was not personally liable for repayment of the debt. 16

4.

Dunnigan and his wife filed for a legal separation in 2009 but were not divorced that year. His wife subsequently filed her 2009 individual income tax return with a filing status of “married filing separately.”

5.

Dunnigan filed his 2009 return with a filing status of “single.” He also reported a total of $68,360.95 of cancellation of debt income that consisted of three discharges of indebtedness from entities other than Swift. He did, however, include with his return a copy of the Form 1099-C issued by Swift and handwrote on it the following: PLEASE NOTE: SWIFT FINANCIAL INDICATED TO ME THAT I AM NOT LIABLE FOR REPAYMENT OF CANCELLED DEBT. I HAD EXPLAINED TO THEM THAT I HAVE A SERIOUS CANCER PROBLEM, AND THAT I’M 76 YEARS OLD. THUS, THEY MARKED BOX 5 ‘NO.’ THE LOCAL IRS OFFICE SUGGESTED I EXPLAIN THE SITUATION AT TIME OF FILING, AND FELT IT WOULD LIKELY COME UNDER ‘HARDSHIP’ RULES FOR APPROVAL.

Opinion of Tax Court 1.

The issue remaining for decision is whether he had discharge of indebtedness income from Swift for 2009. Income from discharge of indebtedness (also called cancellation of debt) is included in the general definition of gross income under §61(a)(12). The concept of discharge of indebtedness income is that a taxpayer has realized an accession to income to the extent that he has been released from indebtedness because assets previously offset by the liability arising from the indebtedness have been freed. Cozzi v. Commissioner, 88 T.C. 435, 445 (1987) (citing United States v. Kirby Lumber Co., 284 U.S. 1 [10 AFTR 458] (1931).

2.

Dunnigan testified that he received the income from the Swift line of credit, and the Court stressed that the burden of proof lies with the taxpayer to show why the discharge of indebtedness income should not be taxable. (Rule 142(a)).

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3.

He first argues that Swift did not hold him personally liable for the repayment of the debt and it indicated this result on Box 5 of Form 1099-C. Cancellation of debt income, however, may be realized without a taxpayer’s personal liability for a debt. See, e.g., Gershkowitz v. Commissioner, 88 T.C. 984, 1006 (1987) (determining that taxpayers realized cancellation of debt income where a creditor discharged their nonrecourse loans in exchange for cash settlements). Dunnigan did not establish that he had no obligation to repay the borrowed funds. Swift’s credit agreement with him and Dunnigan Appraisal provided that he was individually and severally liable for repayment of the credit line, in direct opposition to the Box 5 indication.

4.

Dunnigan alleges that Swift and IRS employees told him that “hardship” rules could apply in his case. However, he does not point to any legal authority that addresses a “hardship” exception to the taxability of discharge of indebtedness income. While there are exceptions to the recognition of such income under §108(a) for cases of bankruptcy and insolvency, but the record does not show that petitioner was either bankrupt or insolvent in 2009.

5.

His reliance on alleged statements of Swift and IRS employees is also unpersuasive. A trial before the Court is a proceeding de novo, and our redetermination of a taxpayer’s tax liability is based on the merits and not on any matters occurring before the notice of deficiency was sent. Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324, 327-328 (1974). Additionally, administrative guidance by the IRS is not binding on the Government, nor can it change the plain meaning of tax statutes. See Miller v. Commissioner, 114 T.C. 184, 195 (2000) (addressing specifically IRS publications), aff’d sub nom. Lovejoy v. Commissioner, 293 F.3d 1208 [89 AFTR 2d 2002-2989] (10th Cir. 2002).

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While the Court did not doubt that Dunnigan experienced hardship, it was not of a kind that controlled in this matter. He received approximately $50,000 in 2009, paid back approximately $15,000 and when his debt was discharged by Swift. Dunnigan had an accession of income because he did not have to pay back the remainder. That income is taxable.

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In reaching the decision the Tax Court considered all arguments made, and to the extent not mentioned they concluded that they were moot, irrelevant or without merit.