Discussion:Cancellation of Debt State of California

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Discussion Forum Index --> Tax Questions --> Cancellation of Debt State of California


NSS (talk|edits) said:

29 January 2010

I have a single taxpayer who received a 1099 C for 2009 for COD box 2 - $159,209.

Assuming this was one note and all non recourse debt.

The 2007 mortgage relief act allows $1,000,000 to be excluded from income for federal purposes.

California does not conform and only excludes $125,000 for single taxpayers. I need some assistance of what other information i need and how to report this. If i can show he was insolvent at the time is the total amount excluded from in income in California.? Any and all assistance would be appreciated.

Tkelly911 (talk|edits) said:

29 January 2010
I don't know where you are getting $125,000, as I thought California non-conformity was complete as of January 1, 2009 for the 2007 act. But California does conform to the insolvency and bankruptcy exceptions, among others, found in the Internal Revenue Code.

DaveFogel (talk|edits) said:

29 January 2010
If the debt was nonrecourse, there is no COD income, so California conformity doesn't matter. The principal amount of the debt is treated as the "amount realized" in the foreclosure/short sale. See 2925 Briarpark Ltd. v. Commissioner, 163 F.3d 313 (5th Cir. 1990); Commissioner v. Tufts, 461 U.S. 300 (1983); Treas. Reg. §1.1001-2(a)(1); L&C Springs Associates et al. v. Commissioner, 188 F.3d 866 (7th Cir. 1999).

Report the $159,209 as part of the selling price. For example, if the property was foreclosed on, the debt was $559,209, and the FMV of the property was $400,000, then the lender will report $159,209 as COD income on Form 1099-C. If the debt was nonrecourse, report the sale on the return as follows:

Foreclosure of property:
Canceled debt per Form 1099-C - $159,209
Balance of debt satisfied with FMV of property - $400,000
Amount realized in foreclosure - $559,209

Then, subtract adjusted basis to get gain or loss. If this was a personal residence, the loss isn't deductible.

NSS (talk|edits) said:

29 January 2010
Dave

Your response is extremely helpful. If you are familiar with Lacerte can you also provide some guidance where all this information is reported. THANK YOU

WillyB (talk|edits) said:

29 January 2010
Dave -

Do you mean that the 559,209 amount realized all goes on Schedule D?

With 159,209 CODI reported, won't the IRS will be looking for this amount on the page 1, other income line? (or somewhere as ordinary income).

I would think some explanation is needed as to why the CODI is not reported as ordinary income.

DaveFogel (talk|edits) said:

29 January 2010
NSS - I don't use Lacerte, so I can't help you.

WillyB - If this was a personal residence, then I recommend reporting it on Sch. D. The IRS will NOT be looking for COD income on the 1040 because the IRS knows that there is no COD income if the debt was nonrecourse, and this is discussed in Pub. 4681. However, because a Form 1099-C was issued, the IRS will probably be looking for some sort of a disclosure on the return, which is why I suggest reporting the transaction on Sch. D. It will probably result in a loss, which should be backed out since the loss is not deductible. For example, if the basis is $600,000, here's how you might report the sale on Sch. D:

Image:1040-SchD.jpg

Tkelly911 (talk|edits) said:

30 January 2010
Dave, the position of the IRS at appeals in two of my non docketed cases involving a 1099-C was that COD income results from a loan modification reducing the balance of the loan even in the case of non-recourse debt, where there was no disposition of the property. They cited IRC § 108(e)(5). This is why California conformity would matter. Do you have a contrary take in this area? Because I could use one. I have now seen several cases where clients come to me from tax professionals having been reassured they have no tax liability only to have the IRS pursue the issue based on these circumstances (reduction of principal). In the two cases to which I refer the clients prevailed based upon insolvency, not the non-recourse nature of the debt.

DaveFogel (talk|edits) said:

30 January 2010
Tkelly911, the IRS is correct. In a loan modification, where there is no disposition of the property, COD income results from a reduction of the principal amount of the loan, and this is true whether the loan is recourse or nonrecourse. See United States v. Kirby Lumber Co., 284 U.S. 1 (1931); Gershkowitz v. Commissioner, 88 T.C. 984 (1987); Rev. Rul. 82-202, 1982-2 C.B. 35, amplified by Rev. Rul. 91-31, 1991-1 C.B. 19.

IRC §108(e)(5) applies to a slightly different situation. This section applies when the person who sold the property has taken back a loan, and subsequently reduces the principal amount of that loan. IRC §108(e)(5) allows the reduction in principal to be treated as a reduction of the selling price.

NSS (talk|edits) said:

30 January 2010
Interesting conversation. and useful information thank you to all.

My client has a 1099-C COD income as a result of giving the home back to the bank. there was no loan modification.

So to confirm, if the loan was secured by the home only, it does not matter how much the debt forgiveness is because it is non recourse debt?

DaveFogel (talk|edits) said:

30 January 2010
The mere fact that the loan is secured by the home does not determine whether the loan is recourse or nonrecourse. I discussed this in an article I wrote about foreclosures and short sales. Here's a link: http://fogelcpa.com/Documents/FogelForeclosuresCSEA-2.pdf

To summarize, in a loan modification where there is no disposition of the property, COD income results from a reduction of the principal amount of the loan, and this is true whether the loan is recourse or nonrecourse.

If there was a disposition of the property, you first have to determine whether the debt was recourse or nonrecourse.

If the debt was nonrecourse, then there is no COD income. Instead, the transaction is treated as a sale or exchange, and the principal amount of the debt is the "amount realized" in that sale or exchange.

If the debt was recourse, then the transaction is split into two parts (“bifurcated”):
(1) If the principal amount of the debt exceeds the property’s FMV, then either a continuing debt obligation is owed to the lender (no cancellation of the debt) or there is COD income equal to the difference between the amount of the debt and the FMV of the property; and
(2) Gain or loss on the sale or exchange equal to the FMV minus adjusted basis.
See Treas. Reg. §1.1001-2(a)(2); Example (8) at Treas. Reg. §1.1001-2(c); Rev. Rul. 90-16, 1990-1 C.B. 12. The COD income portion might be excludable under Sec. 108, and if the transaction involves the taxpayer’s principal residence, the gain portion might be excludable under Sec. 121.

Tkelly911 (talk|edits) said:

31 January 2010
Thank you as always, Dave. I want to repeat for the benefit of this online community that you are held in high regard by my fellow California tax attorneys as one of the best tax technicians in California, and that you are also a prolific author of well researched articles which are used widely by tax counsel here. All well worth reading. I know I have certainly learned a lot of useful information I have used against the Service.

EZTAX (talk|edits) said:

31 January 2010
Agree with Tkelly - thanks for all the great info Dave.

One follow-up. It is my understanding that a the bank cannot chase you for a deficiency on a recourse loan if they do not go through a judicial foreclosure. Does the fact that there is not a judicial foreclosure on a recourse lona have any effect on the tax treatment?

TexCPA (talk|edits) said:

31 January 2010
Dave,

Thank you for your contribution, I think you have set the bar with this answer/respone. Very infomative / with cites!

TexCPA

DaveFogel (talk|edits) said:

31 January 2010
Thank you all for your kind remarks. They keep me going.

EZTAX, I guess what you're asking is this: if the lender uses the nonjudicial foreclosure process to foreclose on a property, does this convert an otherwise recourse loan to a nonrecourse loan? No. Whether a loan is recourse or nonrecourse depends upon the rights that the lender has, not what the lender decides to do with those rights.

In California, the judicial foreclosure process is used when the lender wants to obtain a deficiency judgment against the borrower. The deficiency is what's still owed after the lender takes the property and it doesn't fully satisfy the amount owed. To use the judicial foreclosure process, the lender is required to sue the borrower in court to take the property back from the borrower. It is unlikely that a lender would use this process unless there is evidence that the borrower has significant assets to pay the deficiency judgment, because it is much easier and less expensive to use the nonjudicial foreclosure process.

In California, the loan document or Deed of Trust usually contains a "power of sale" clause, and this clause allows the lender to sell the property at auction when the borrower is in default. To begin the nonjudicial foreclosure process, the lender files a notice of default with the county recorder’s office. There is a waiting period (period of redemption) that allows the borrower to bring the loan current, and after this period expires, the the property can be sold at auction (trustee's sale).

Neither process converts a recourse loan to a nonrecourse loan or vice versa.

NSS (talk|edits) said:

31 January 2010
Dave,

It has been a pleasure meeting you via our on line discussion. I am glad I asked the question, and extremely grateful that i had such a knowledgeable person respond.

The article you forwarded http://fogelcpa.com/Documents/FogelForeclosuresCSEA-2.pdf, has been the most useful information that I have read on this issue.

Thank you

DaveFogel (talk|edits) said:

1 February 2010
NSS, thank you for your comments. After you have read this article, which deals with the foreclosure or short sale of a principal residence, you might want to read my second article, which deals with the foreclosure or short sale of rental properties. Here's the link: http://fogelcpa.com/Documents/FogelRentalForeclCSEA.pdf

Belle (talk|edits) said:

February 1, 2010
Dave, where do we send our 'tokens' of appreciation for your generous sharing of such concise, valuable knowledge?

Tax6376 (talk|edits) said:

30 March 2010
I have a client(Single Tax payer) with a situation of Short sale on his house and need some advice from the experts here. My client has a 500K loan which was taken on his primary residence so i guess it will be treated as a non-recourse loan. After coming to settlement with the lender and agreeing for a short sale my client is poised to owe about 250K to the lender.

I was under the impression that he should be able to use the 2007 mortgage relief to get COD on his case and file his 1099C accordingly. But i am hearing State of California doesnt not conform with the debt forgiveness act and he will be taxed on the 250K he owes the lender. Is this true? Are there any other options for my client? I am reading mixed information on the web that he should be able to get a COD on his case since its a non-recourse loan and was taken on his primary residence. I also read that SBx8 32 was vetoed by Governor yesterday so how does this impact all the folks who are in this situation when they file their 2009 taxes? Any help is appreciated

DaveFogel (talk|edits) said:

30 March 2010
If the loan is nonrecourse, then there is no COD income, and therefore, no need to consider either the principal residence exclusion of IRC §108(h) that was enacted by the Mortgage Forgiveness Debt Relief Act of 2007 or California nonconformity to this exclusion.

If nonrecourse debt is canceled in exchange for transfer of the property securing the debt, the transfer is treated as a sale or exchange, i.e., no COD income. See 2925 Briarpark Ltd. v. Commissioner, 163 F.3d 313 (5th Cir. 1990). Instead, the "amount realized" in the sale is the principal amount of debt. See Commissioner v. Tufts, 461 U.S. 300 (1983); Treas. Reg. §1.1001-2(a)(1); L&C Springs Associates et al. v. Commissioner, 188 F.3d 866 (7th Cir. 1999).

Tax Writer (talk|edits) said:

30 March 2010
The bill is expected to pass eventually, because the Governator supports conformity on this issue. So we have about 15 clients that will be e-filed for Federal and then we are waiting on the CA returns until the law passes, which is expected to be after April 15th.

Tax Writer

Lesa (talk|edits) said:

31 March 2010
DaveFogel is right. This may help too.

California Code of Civil Procedure § 580b

Tax Writer (talk|edits) said:

31 March 2010
Dave, your articles on forclosures are fantastic. I just fowarded the links to our managing partner. I'm very impressed!

Tax Writer

DaveFogel (talk|edits) said:

31 March 2010
Thank you.

Bobmccay (talk|edits) said:

1 April 2010
A slightly different twist on the recourse/nonrecourse issue. My client bought his house (that has since gone through a short sale) and subsequently rented out rooms in it for a couple of years before the short sale. Does the debt keep the nonrecourse attribute or does the fact of renting switch it to recourse for the rental portion? If it is non-recourse he has an ordinary loss, as I see it, on the sale of the rental portion and a personal loss on the sale of the residence portion. If it switches to recourse on the rental portion then he has COD, which I can clear by use of the insolvency exclusion.

Bobmccay (talk|edits) said:

1 April 2010
A slightly different twist on the recourse/nonrecourse issue. My client bought his house (that has since gone through a short sale) and subsequently rented out rooms in it for a couple of years before the short sale. Does the debt keep the nonrecourse attribute or does the fact of renting switch it to recourse for the rental portion? If it is non-recourse he has an ordinary loss, as I see it, on the sale of the rental portion and a personal loss on the sale of the residence portion. If it switches to recourse on the rental portion then he has COD, which I can clear by use of the insolvency exclusion.

DaveFogel (talk|edits) said:

1 April 2010
In my opinion, renting out rooms in the residence does not convert the nonrecourse debt to recourse. Be careful about deducting a loss for the rental portion because the adjusted basis for computing loss is the lower of cost or FMV at the time that the property (or the portion thereof) was converted to rental use. See Treas. Reg. §1.165-9(b)(2).

Bobmccay (talk|edits) said:

1 April 2010
Thanks so much. Kind of what I thought. He started renting out rooms soon after he moved in, so the FMV is probably pretty close to the purchase price, but it is a good point.

Lalva (talk|edits) said:

3 February 2012
Please help! I am trying different things without the wanted results.

Two things:

1) I have a client with a 1099-C that I believe it's incorrect. It says that my client is personally liable, but this was an original loan to purchase his house. The loan was sold or transfer to another bank, maybe that's why.

2) I need to enter what Dave Fogel posted in this thread (I use ProSeries) and I cannot enter the info directly in the Sch D or Form 8949. I have to fill out the worksheet for the 1099-C (although there is no CODI due to non-recourse loan). The worksheet somehow doubles the amount of selling price and loss. I don't know what I am doing wrong, but if I answer the questions correctly I get the wrong numbers. It seems weird to enter wrong information to get the correct outcome.

Thank you in advance.

Lalva (talk|edits) said:

3 February 2012
Something else, the California return shows a HUGE amount due because it adds the non-deductible personal loss (for the personal residence short sale) as income.

I don't know what is going on. ProSeries users out there: Have you had any problems with the software this year?

Thank you again!

DaveFogel (talk|edits) said:

3 February 2012
I use ProSeries, and you can get some weird results if you use the Canceled Debt Worksheet to enter information from a Form 1099-C when the debt was nonrecourse. Recommend that you remove the worksheet and instead enter the information directly onto Schedule D as shown in the example above.

Lalva (talk|edits) said:

3 February 2012
Thank you Dave for your help.

I could enter the info directly in previous years version of ProSeries, but now with the new form I cannot do it. Ugh! There must be a way to do it, but I don't seem to find it.

Lalva (talk|edits) said:

4 February 2012
I partially solved the problem by entering wrong numbers in the 1099-C worksheet to arrive to the correct sales amount (total debt) and correct non deductible loss. I don't like it, but it's the only way to get it right on the sch D. This year I cannot enter info directly in the Sch D for some reason.

In the California return there is a huge amount of tax due because the Sch CA was adding the big non deductible loss back to income. When I checked why, in the California Sch D the selling price and cost basis for some reason was the same amount. Then there was another line for the "Disallowed loss from personal use property" and adding that amount back.

Well, I will call ProSeries tomorrow because this doesn't sound right. I will have to override that amount.

Lmasseycpa (talk|edits) said:

22 May 2012
Slightly different twist to the thread...I have a client who went through the Bankruptcy process with two rental properties...one that was initially a primary residence (I would expect this to be treated as Nonrecourse), and one that was a rental/business property from the inception, never lived in by the taxpayer (which I believe to be a recourse loan).

All debt associated with the properties were listed in the bankruptcy, and the properties were listed as intended to be surrendered to the lenders.

After the BK, the taxpayer sold both properties in short sales. Now the question...are both of these loans nonrecourse after exiting the BK? Would this be something that I need to review the final BK language to see if the Judge addressed the debt?

(Thanks for your response in advance)...and thanks for your articles Dave! I agree with other posters, the articles are clear and concise...though, of course, this is a complex evolving area of tax law...I do especially like your foreclosure/short sale flow chart...it's a useful quick reference when dealing with these matters!

Lmasseycpa (talk|edits) said:

22 May 2012
Slightly different twist to the thread...I have a client who went through the Bankruptcy process with two rental properties...one that was initially a primary residence (I would expect this to be treated as Nonrecourse), and one that was a rental/business property from the inception, never lived in by the taxpayer (which I believe to be a recourse loan).

All debt associated with the properties were listed in the bankruptcy, and the properties were listed as intended to be surrendered to the lenders.

After the BK, the taxpayer sold both properties in short sales. Now the question...are both of these loans nonrecourse after exiting the BK? Would this be something that I need to review the final BK language to see if the Judge addressed the debt?

(Thanks for your response in advance)...and thanks for your articles Dave! I agree with other posters, the articles are clear and concise...though, of course, this is a complex evolving area of tax law...I do especially like your foreclosure/short sale flow chart...it's a useful quick reference when dealing with these matters!

DaveFogel (talk|edits) said:

22 May 2012
The portion of the debt in excess of the FMV of the property was discharged in bankruptcy, and the portion of the debt equal to the FMV of the property that survived the bankruptcy is treated as a nonrecourse loan. See Letter Ruling 8918016.

Lmasseycpa (talk|edits) said:

22 May 2012
Hi Dave - GREAT cite, and amazingly fast! Thank-you...I will put this to good use, and share it with other tax professionals!

Larry

Tax Writer (talk|edits) said:

22 May 2012
FYI; for those in CA, Gov. Brown just signed SB 458 into law. SB 458 ensures that any lender that agrees to a short sale must accept the agreed upon short sale payment as payment in full of the outstanding balance of all loans. So, it makes every short sale into a nonrecourse debt. It applies to junior leinholders (seconds) as well as primary lienholders, which is very taxpayer-friendly. SB 458 applies to investment property (up to 4 unit properties) and the property doesn't need to be owner occupied. SB 458 does not apply to foreclosures, only short sales.

Under previous law (SB 931 of 2010), a first mortgage holder could accept an agreed-upon short sale payment as full payment for the outstanding balance of the loan, but unfortunately, the rule did not apply to junior lien holders. SB 458 extends the protections of SB 931 to junior liens.

I just learned about this today from a CPA friend and I thought it was exciting news.

DaveFogel (talk|edits) said:

22 May 2012
Tax Writer, I'm sorry that I have to correct you, but SB 458 was signed into law over 10 months ago on 7/15/2011 (Chapter 82). It amended section 580e of the California Code of Civil Procedure (CCP) for short sales.

The section does not convert an otherwise recourse loan into a nonrecourse loan. Rather, a lender that agrees to a short sale is prevented from seeking a deficiency judgment against the borrower for the balance of the debt not satisfied by the proceeds from the short sale. It essentially does the same thing as CCP §580d, which applies to a non-judicial foreclosure. See my article, “Does a Non-Judicial Foreclosure Convert Debt From Recourse to Non-Recourse?”.

Tax Writer (talk|edits) said:

23 May 2012
Tax Writer, I'm sorry that I have to correct you,

Argggh! Bested by Dave Fogel again!

Lmasseycpa (talk|edits) said:

23 May 2012
Well, I still think SBs 458/931 are exciting news...though I didn't learn about them today...I agree with Dave that those bills don't make existing loans Nonrecourse...though that is the effect from a financial standpoint...from a tax standpoint for determination of COD income and gain/loss on sale, a recourse loan is still a recourse loan...unless it's not...


Trillium (talk|edits) said:

2 November 2012

NOTE - one question posted here today (1) was not about the differences between federal and California treatment, which is the topic of this discussion, and (2) was posted by someone who is not eligible to participate on the pro tax forum. That post has been moved to the Consumer Forum, and the poster was notified.

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