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Discussion:Bankruptcy and Abandonment

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Discussion Forum Index --> Tax Questions --> Bankruptcy and Abandonment

Riley2 (talk|edits) said:

17 May 2007
I received this inquiry:

In several discussion posts you have noted the difference between the Cancellation of Debt income and the gain created on abandonment of property. Whether the debt is recourse or not determines the breakdown of what is COD and what is taxable gain. A chapter 7 bankruptcy does effectively make the COD income non-taxable, but in the process wipes out all the basis of the property abandoned. As a result, this leaves a gain on abandonment that I believe you define as taxable on form 4797 even in title 11 cases.

In my research I came across the following:

"According to the majority of courts that have decided or considered this issue, particularly the Eighth Circuit, an abandonment of property from an estate while the bankruptcy case is still pending does not result in a taxable sale, exchange, or other disposition. In the leading case from the Eighth Circuit, the bankruptcy court determined that an abandonment of property constituted a transfer upon the termination of the estate within the meaning of Code Section 1398(f)(2). In re Olson, 100 B.R. 458, 463 (Bankr. N.D. Iowa 1989), aff'd, 930 F.2d 6 (8th Cir. 1991). Courts favoring the majority position generally follow the reasoning set forth in In re Olson. The IRS follows the holding of In re Olsen as well.

OBSERVATION: The government benefits from this treatment because it shifts the tax burden to the debtor who, upon the subsequent disposition of the abandoned property, may recognize a taxable gain that will result in a non-dischargeable, post-petition tax liability."

This seems to indicate in this circumstance that the 4797 gain is excluded as well and reported on form 982 along with the COD income. My confusion comes from whether the individual has the right to exclude or only the estate - or does it matter? The 1099-A came in under the debtor's SSN and the bankruptcy trustee did not file a 1041 because "the estate had no items of income".

Do you agree with the above interpretation, or am I just looking for the answer I want too hard?

Riley2 (talk|edits) said:

17 May 2007
Be careful not confuse a “tax abandonment” with an “abandonment” under bankruptcy law. When the trustee abandons property, he is basically saying that the property is of insignificant value, making the property revert back to the debtor. Obviously, this is not a taxable event. See Sec. 1398(f)(2).

Secondly, a Chapter 7 discharge does not wipe out basis in the deemed sale from the abandonment. The basis reduction is generally made on the first day of the year following discharge. An exception to this general rule is made for COD income from "qualified real property indebtedness", in which case only the excess of the amount of the indebtedness over fmv of the property is treated as COD income to which the basis reduction rules apply.

Thirdly, the gain on Form 4797 is not excludible on Form 982 under Internal Revenue Code § 108 at all. Only COD income is excludible under Sec. 108. No other exclusions are allowed on Form 982.

Lastly, if the trustee allowed the property to go into foreclosure after the property had been transferred into the bankruptcy estate, the trustee would be responsible for reporting the gain from the abandonment and cancellation of debt (unless the trustee abandoned the property to the debtor). Again, any COD income would be excluded under Sec. 108, but any gain from the deemed sale would be subject to the normal taxes on bankruptcy estates.

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