Tax Attributes - Exempt Assets

[joejoebk]

After filing Chapter 7 in early 2011, I received a 1099-C from a creditor and was informed by the IRS that I would need to "reduce the tax attributes" of my property (as of 1/1/2012) by the amount of the discharged debt.

Situation:
- Personal Chapter 7 in MN (used federal exemptions)
- Single at the time of filing through discharge
- Married a few months after discharge
- Primary residence (FMV ~$150k) w/ $145k mortgage
- Claimed exemptions on Schedule C (summary) as follows:
a. primary residence ~$5k exempt
b. personal property ~$6k exempt
- No "non-exempt" assets
- ~$80k discharged in personal credit cards, medical bills, etc.

- Received 1099-C (~$10k) from credit card company. The card was originally a "business" card that I personally guaranteed many years ago, but was 100% personal use for 5+ years.

- Wife has ~$500k in brokerage account
- Wife has ~$100k in personal assets

My questions are:

1) Do I need to reduce the basis in any of the property that was claimed as "exempt?"
2) Since we were married in July, are my wife's assets (as of 1/1/2012) considered "mine" to apply tax attribute reduction?
3) Would I need to reduce the basis in future assets I purchase?*

*If I understood the representative I spoke with at the IRS, she stated that if a person had nothing more than the shirt on their back, they would need to reduce the tax attributes of future assets they acquire. I have not read anything that would support this, but that is why I ask.

Thanks for any help!!

[keepmine]

Since the debt was dischared in bk, you need to file IRS form 982. Go to the IRS site and judt type form 982 in the search function and you'll find all the info you need.
No need for something convoluted.

[joejoebk]

I have looked at Form 982 extensively, but I can't seem to understand if I am supposed to reduce the tax attributes of my primary residence. Additionally, while I had no "non-exempt assets" at the time of discharge, the IRS informed me that I need to reduce the tax attributes of any assets I had on 1/1/2012. Since many of the assets that I had on that day are owned jointly by my wife and I...are those impacted by a reduction of tax attributes.

Thanks for your time and consideration!

[HHM]

No, you don't do ANYTHING related to your BK regarding the assets.

You use Form 982 to address the 1099-C you received from the credit card company, so that has to be done. The creditor knows your filed BK, the IRS does not (in a legal sense), so if you get a 1099-C from a creditor after BK, you must fill out 982 to address that 1099-C.

What tax deductions are you taking that would even require you to adjust a basis on "personal" property and a "primary" residence.

Basis adjustments is only done in the context of depreciation which is applicable to business assets and investment properties.

[joejoebk]

Hi HHM and thanks for your response.

When I spoke with the IRS, they directed me to Form 982 and told me to follow the instructions on page 2 for "a nonbusiness debt."

1. Check the box on line 1a if the discharge was made in a title 11 case (see Definitions on page 3) or the box on line 1b if the discharge occurred when you were insolvent (see Line 1b on page 3).

2. Include on line 2 the amount of discharged nonbusiness debt that is excluded from gross income. If you were insolvent, do not include more than the excess of your liabilities over the fair market value of your assets.

3. Include on line 10a the smallest of (a) the basis of your nondepreciable property, (b) the amount of the nonbusiness debt included on line 2, or (c) the excess of the aggregate bases of the property and the amount of money you held immediately after the discharge over your aggregate liabilities immediately after the discharge.

____

1 - clearly I check box 1a (as the discharged debt was part of a title 11 case)
2 - I would put the total of the 1099-C (not total debt of bk) on line 2.
3 - #3 is where I am completely lost. The IRS representative led me to believe that since the debt would have been paid back with aftertax $$$ if it had not been discharged, the discharged amount would need to be applied to reduce the tax attributes of any assets I may sell and would need to then pay taxes on the gain.

For example, if I had an asset that I purchased 5 years ago for $150k and sold it in 30 years for $750k, I would need to pay tax on the $600k gain. However, if I retained the asset through a title 11 bankruptcy that had a debt of $100k discharged, I would need to reduce the basis in the asset proportionately. As a result, I would need to pay taxes on a $700k gain.

This does not seem correct to me, but it is the way the IRS explained it to me. Further, I asked the IRS representative "what if I only had the shirt on my back" and not even an "exempt" asset? To which, she replied, I would need to reduce the attributes of future assets I acquired until the entire discharged debt has been satisfied. So, if my discharged debt were $100k, the first $100k of future assets would have there basis reduced to $0. If any of those assets were sold (even for a loss) the taxable basis would be calculated as though $0 had been paid for them.

Sorry for the lengthy response/explanation. I appreciate your help.

[HHM]

Okay, let me preface with...verify with a tax professiona...

You are referring to Part II of form 982. You do NOT DO ANYTHING with Part II or Part III. Part II is generally used in the context of a business and Part III is for Corporations. Nothing you need to do beyond Part I. The IRS "agent" (a $10 per hour employee that has had a 4 hour training class) is just giving a standard script.

Part II is only used if you have depreciable property. Your personal belongings, retirement accounts, and primary residence (simply understand it as non-business assets) do not fall into this category.

Let me give a brief example. Let's say you own a rental property that you bought for $150,000, and you bought it 10 years ago. Let's say you rent it for $1,000 per month. The IRS allows you to depreciate that asset and take that depreciation as an offset to income. (there is a very particular schedule of how things get depreciated, so this is not "real" example). So each year, you write of $10,000 of depreciation. Along with other expenses, that depreciation off sets the $12,000 in rental income you receive from the property thereby reducing the tax you must pay, or in most cases, given you a loss to offset other income. In any event, the original "basis" for the property was $150,000...after 10 years of depreciating the property at $10,000 per year, your "adjusted" basis would be $50,000. What this matters is in the capital gains area. If you later sell the house for $200,000, you are liable for capital gains on $150,000 ($200,000 - $50,000), not just $50,000 ($200,000 - $150,000). What Part II of Form 982 allows (along with regulation 1017), is to apply forgiven debt to adjust the basis of a depreciable asset.

So, all that to say, there is NOTHING you need to do with Part II of form 982. You don't appear to have depreciable assets. You just need to fill out Part I, sign, and your done.

[joejoebk]

First, let me say thank you very much for your clear and complete explanation!

While the asset was my primary residence through the bk, what would happen if I turned it into a rental property? I don't know when, but it is very likely my wife and I will want to move in the near future and the property is worth substantially less than what I bought it for, but I could likely make it breakeven with rents. Would the basis be adjusted or the property otherwise affected in this scenario?

Additionally, in regards to the reduction of tax attributes of personal property, the IRS representative also pointed me toward Publication 4681 (found on IRS website). Specifically, look at:

Page 4 - under the "Bankruptcy" section; "Enter the total amount of debt canceled in your title 11 bankruptcy case on line 2. You must also reduce your tax attributes on Part II on Form 982 as explained under 'Reduction of Tax Attributes' later."

Page 8 - under "Reduction of Tax Attributes" section; "No tax attributes other than the adjusted basis of personal-use property you own, you must reduce the basis of the personal-use property you held at the beginning of 2012."

If part II is exclusively for business, why do they reference "personal-use property you held at the beginning of 2012?"

[HHM]

Stop over thinking this...The "event" in question is the BK and the discharge of the debt in the BK. What you do with property now doesn't matter.

Let me make this simple....HAVE you ever depreciated an asset on a prior years tax return and still own that asset as of the filing BK.

If, no (which I suspect is the case)...stop already and relax.

The problem is you are only reading enough to get you into more trouble but not seeing the big picture.

Finally, there is nothing mandatory about Part II, part II is an "election" (or option). Part II give the taxpayer and "option" to take some or all of forgiven debt to adjust the basis of depreciable assets. Again, don't worry about it.

The fact that you don't understand this...is even more reason to know that Part II does not apply to you.

[TheBajan]

HHM is absolutely correct. You are way over-thinking this. Pay attention to Part I as it pertains to the 1099C and leave part II and III alone. Whatever you decide to do in the future has nothing to do with your BK. As HHM already said, if you haven't taken depreciation in the past... those sections have nothing to do with you.

Cheers!

[joejoebk]

Thank you both! As for depreciation from the past, I did rent my property out from late-2006 to mid-2009. During that period, I depreciated the building to offset the rental income and my income from other sources. I never had any NOL or other carryover.

Building value (2006) = $145k
Yearly depreciation = $5,272 ($145k/27.5yrs.)

The history of my property is:
- Purchased in May 2005 for $192k
- It was my primary residence until November 2006
- Rented the unit out from November 2006 - August 2009
- Moved back into property in August 2009
- Property has been my primary residence since August 2009

- Estimated FMV of property today is ~$125k

Does this impact how I should handle Form 982?

What would result if we converted the property into a rental in a few months?

Would we use the adjusted basis from the original purchase price?

Thanks!

[HHM]

I wouldn't think so, because it is back to being your primary residence and has been for the last 3 years of so (or at least, from the date you stopped collecting any rent).

Again, just ignore part II, it doesn't help you and it doesn't matter.