When a taxpayer has property that was foreclosed on, repossessed, quitclaimed, or involved in a short sale, there may be cancelation of debt from Form 1099-C that is required to be reported on the tax return. There may also be a gain or loss from foreclosure to report, which is separate from the cancelation of debt income. The taxpayer may also receive Form 1099-A for this property. Any time debt is forgiven or canceled, the preparer should evaluate the circumstances to determine if the transaction should be reported on the tax return. Preparers should consult IRS Publications 544 Sales and Other Dispositions of Assets
and 4681 Canceled Debts, Foreclosures, Repossessions, and Abandonments
for additional information about reporting 1099-C and 1099-A transactions.
If the taxpayer received a Form 1099-A for the abandonment of property, but the debt was not canceled (meaning the taxpayer is still liable for the debt), there are different reporting requirements. This topic addresses only scenarios where debt was forgiven or canceled.
Foreclosure transactions generally have two components to report on a tax return. These instructions assume that the taxpayer was personally liable for the debt. If the taxpayer is not personally liable for the debt, different rules apply.
1. Cancelation of Debt (COD) income:
Just because a Form 1099-C was received, this does not mean that there is cancelation of debt income that has to be recognized on the tax return. To determine cancelation of debt income, use Part 1 of the Worksheet for Foreclosures and Repossessions from Table 1-2 of Publication 544 (or Table 1-1 of Pub. 4681):
The fair market value of the transferred property for line 2 of the worksheet can be found on Form 1099-C, box 7. Generally, the COD income on line 3 of this worksheet will be the same as the amount on Form 1099-C, line 2. Note that a loss from the cancelation of debt is not recognized.
Exceptions: If any of the following exceptions apply, then the cancelation of debt income can be nontaxable, and should not be reported as cancelation of debt income. Also, if any of the exceptions below apply, Form 982 Reduction of Tax Attributes must be completed. Information for this form can be entered in Screen 62, Discharge of Indebtedness (982).
Bankruptcy: Debts discharged through bankruptcy are not considered taxable income
Insolvency: If the taxpayer is insolvent when the debt is canceled, some or all of the canceled debt may not be taxable. A taxpayer is insolvent when his total debts are greater than the fair market value of his assets. Insolvency can be complex to determine. For more information about insolvency, refer to IRS Publication 908 Bankruptcy Tax Guide
Certain farm debts: If the taxpayer incurred the debt directly in operation of a farm, more than half of their income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, his/her canceled debt is generally not considered taxable income.
Non-recourse loans: A non-recourse loan is a loan for which the lender's only remedy in case of default is to repossess the property being financed or used as collateral. In other words, the lender cannot pursue the taxpayer personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancelation of debt income. However, it may result in other tax consequences.
The cancelation is intended as a gift.
The debt is qualified real property business debt.
The debt is qualified principal residence indebtedness discharged before January 1, 2013 (per the Mortgage Forgiveness Debt Relief Act of 2007). See the Qualified Principal Residence Exclusion section below.
Where is cancelation of debt income entered in the program? This depends upon whether the property is PERSONAL or BUSINESS.
PERSONAL PROPERTY: Cancelation of debt income from personal property is entered in Screen 14.1 Miscellaneous Income, in the Alimony and Other Income section, in the field Cancelation of debt (1099-C) (code 6 or 56):
Qualified Principal Residence Exclusion: The Mortgage Relief Act of 2007 allows for an exclusion of up to $2 million (or $1 million if married filing separate) of cancelation of debt from income if it was from qualified principal residence indebtedness. The discharge of indebtedness for a qualified principal residence can be entered in Screen 14.1 Miscellaneous Income, in the Alimony and Other Income section, in the field Qualified principal residence exclusion (code 7 or 57). Generally, if you exclude canceled debt from income under one of the exclusions listed above, you must include Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. (see Exceptions section above).
BUSINESS PROPERTY: Cancelation of debt income on business property should be reported as income in the business activity in which the property was used. For example, if the property was a rental home, the cancelation of debt income should be entered as "Rents received" in Screen 18, Rental & Royalty Inc. (Sch. E). If the property was used in a Schedule C business, then the cancelation of debt income would be entered in the field Other income in Screen 16, Business Income (Sch. C). Cancelation of debt income on business property should not be entered in Screen 14.1.
2. Gain or Loss from Foreclosure or Repossession: A foreclosure or repossession is treated as a sale or exchange, and gain or loss may need to be recognized, even if the property is voluntarily returned to the lender. The gain or loss from foreclosure or repossession is computed independently from the computation of cancelation of debt income. The gain or loss from foreclosure or repossession is the smaller of the debt discharged by the lender or the fair market value of the property, plus proceeds received from the foreclosure sale, minus the adjusted basis of the property. The second part of the Worksheet for Foreclosures and Repossessions from IRS Pub. 544 or Pub. 4681 (referenced above) can be used to compute the gain or loss from foreclosure or repossession:
How do I enter the gain or loss from foreclosure in the program? The gain or loss from foreclosure can be entered in Screen 17, Dispositions, or Screen 22, Depreciation if the property is business property already being tracked in the Depreciation screen. In reporting the gain or loss from foreclosure, the Sales price entry should be the lesser of:
a) the amount of outstanding debt immediately before the foreclosure (amount canceled/forgiven); or
b) the fair market value of the property
any proceeds received from the foreclosure sale
PERSONAL PROPERTY: The gain from foreclosure for personal property should be entered in Screen 17, Dispositions. The following entries should be made:
If the property was the taxpayer's principal residence and there is a gain from foreclosure to recognize, the taxpayer may be able to exclude this gain under Section 121, if they meet the ownership and use requirements. Entries should also be made in the Sale of Home section to compute any allowable Section 121 exclusion:
If the transaction results in a loss, then instead of Sale of Home the entry should be made in the following field, in the section labeled Schedule D. Any loss from the foreclosure of personal property is not deductible.
BUSINESS PROPERTY: The gain or loss from foreclosure on business property can be entered in Screen 22, Depreciation or Screen 17, Dispositions.
In Screen 22 Depreciation the following entries are required:
OR if the transaction is reported in Screen 17 Dispositions, the following entries are required: