A taxpayer may elect to exclude 1099-C income due to a discharged qualified real property business indebtedness under IRC §108(a)(1)(D). An eligible taxpayer must make a valid election on a timely filed return (including extensions), to exclude discharged qualified real property business debt from income, by attaching Form 982 to the tax return. A taxpayer may file a late election if an amended tax return is filed within six months of the due date of the return (excluding extensions) under Treas. Reg. §301.9100-2. If an election is not made timely or with an amended return filed within six months of the due of the return, a taxpayer must request permission to file a late election.
In PLR 201316009, 2013 WL 1699430, a taxpayer filed a timely individual tax return in year 1. The taxpayer was a 50-percent partner in a LLC that received cancellation of debt income related to qualified real property business indebtedness. The LLC failed to identify the type of cancellation of debt income and the individual's tax preparer treated the CODI as other income. It was not until year 3 when the tax preparers realized that the taxpayer was eligible to exclude cancellation of debt income under the qualified real property business indebtedness exclusion. The taxpayer subsequently filed a request for an extension to file a late election. The IRS allowed the taxpayer to file an amended return in order for the individual to make the election under Treas. Reg. §301.9100-3(c)(1).
An eligible taxpayer can make this election to exclude CODI and reduce the basis of depreciable real property by the amount of discharged qualified real property business indebtedness. To qualify for this exclusion, IRC §108(c)(3)(A) requires that the real property must be "used in a trade or business." Facts and circumstances must be considered in each case. Rental real estate may qualify under this exclusion if the rental rises to the level of a trade or business. However, the following situations may not qualify under this exclusion.
"…a rental of even a single property may constitute a trade or business under various Internal Revenue Code provisions…However, the ownership and rental of real property does not, as a matter of law, constitute a trade or business. Curphey v. Commissioner, 73 T.C. at 766 (1980) The issue is ultimately one of fact in which the scope of a taxpayer's activities, either personally or through agents, in connection with the property, are so extensive as to rise to the stature of a trade or business."
Bauer v. Commissioner, 168 F.Supp. 539, 541 (Ct.Cl.1958).
Qualified real property business indebtedness is defined as indebtedness that meets all of the following requirements:
There are two limitations, (1) the debt in excess of value and (2) the overall limitation on the amount of discharged qualified real property business debt that can be excluded from gross income under IRC §108(c)(2) and further described in Treas. Reg. §1.108-6.
In applying the first limitation, the amount of qualified real property business indebtedness excludible from gross income cannot exceed the excess of the outstanding principal amount of the qualified real property business debt (immediately before the discharge) over the fair market value (immediately before the discharge) of the business real property that secures the discharged debt, less, the outstanding principal amount of any other qualified real property business debt that secures the property immediately before the discharge.
In applying the second or overall limitation, the excluded debt amount should not be more than the aggregate adjusted bases of depreciable real property held immediately before the discharge, (excluding depreciable real property acquired in contemplation of the discharge) reduced by the sum of depreciation claimed for the taxable year that CODI was excluded under this exclusion plus, reductions to the adjusted bases of depreciable real property required under IRC §108(b) (e.g., bankruptcy or insolvency exclusions) for the same taxable year plus, reductions to the adjusted bases of depreciable real property required under IRC §108(g), the qualified farm exclusion, for the same taxable year.
The qualified real property business exclusion is an election by attaching a Form 982 to a timely filed tax return (excluding extensions) or an amended return filed within six months of the due date of the tax return (excluding extensions). Failure to do so disqualifies the taxpayer from excluding cancellation of debt income from gross income under this exclusion. As such, a taxpayer must make a formal request for a Private Letter Ruling when the taxpayer later discovers that he/she qualifies for this exclusion during an examination. The examiner cannot make the determination when the taxpayer did not make a timely election.
Rev Ruling 2016-15
In Rev. Rul. 2016-15, the IRS ruled on two situations involving individual taxpayers who had debt forgiven on property used in their real property trades or businesses. In the first, the taxpayer was able to defer the gain on debt forgiven on the real property indebtedness, while the second taxpayer was not.
The first situation discussed in the revenue ruling involves an individual who borrowed $10 million from a bank and used it to build an apartment building for use in the taxpayer’s rental trade or business. Before the loan matured, the taxpayer reduced the loan principal to $8 million but was unable to pay it off on the maturity date. The fair market value of the building was $5 million, and the taxpayer’s adjusted basis was $9.4 million. The bank agreed to accept $5.25 million to forgive the loan. The taxpayer was not insolvent or bankrupt when the loan was forgiven. The taxpayer elected to exclude $2.75 million under Sec. 108(a)(1)(D).
Because the taxpayer held the property for use in a trade or business and was allowed to depreciate the property, the debt is qualified real property indebtedness and the taxpayer can exclude the gain from gross income and reduce the basis in the building.
In the second situation, the taxpayer borrowed $10 million to construct a residential community, which the taxpayer subdivided and held for sale. The rest of the facts are the same, and the taxpayer wants to exclude the $2.75 million of forgiven debt from gross income. But, because the qualified real property indebtedness rules require a corresponding reduction in the basis of the property, they cannot be applied to property that is not depreciable in the taxpayer’s hands, which is the case for property primarily held for sale to customers. Therefore, the second taxpayer does not qualify to exclude the income under Sec. 108(a)(1)(D).
In addition, the IRS announced that it was obsoleting Rev. Rul. 76-86, which held that a taxpayer could exclude income arising from indebtedness incurred to buy merchandise for resale. The IRS explained that it was obsoleting the revenue ruling because the current versions of Secs. 108 and 1017 are materially different from the versions in effect when it was issued; thus, the revenue ruling no longer reflects current law.
This clarification appears to have helped landlords with sudden decreases in property values.
1099-C identifiable event codes were added to the 1099-C reporting form in 2013 for 2012 1099-C forms issued.
What Is Form 1099-C?
Form 1099-C is an information return used to report canceled debt to debtors for tax purposes. A debtor does not have income when an amount is borrowed. But, if the debtor does not pay the loan back and the bank forgives part of the loan, then the forgiven portion of the debt constitutes taxable income to the debtor. For example, if a customer takes out a loan for $100 and the bank agrees to discharge the loan for $75, then the customer would have $25 in forgiveness of debt income. Form 1099-C is generally used to report this forgiven debt income. The debtor will generally owe taxes on forgiven-debt income unless the debtor is able to claim an exception from taxation,
such as for insolvency.
When Do Banks Issue Form 1099-C?
Lenders are generally required to issue Form 1099-C after certain trigger events on a debt. These events are identified in tax regulations. Common trigger events include:
Which Code to Use on Forms 1099-C Issued ?
The new codes for trigger events appear in the 2012 and later instructions for Form 1099-C. Brief explanations of each code are set forth within the instructions under the section labeled "When Is a Debt Canceled." The new codes will be input on Forms 1099-C in Box 6 labeled "Identifiable Event Code."
Publication 4681 identifiable event code explanations
Code A — Bankruptcy. Code A is used to identify cancellation of debt as a result of a title 11 bankruptcy case.
Code B — Other judicial debt relief. Code B is used to identify cancellation of debt as a result of a receivership, foreclosure, or similar federal or state court proceeding other than bankruptcy.
Code C — Statute of limitations or expiration of deficiency period. Code C is used to identify cancellation of debt either 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. In the case of the expiration of a statute of limitations, an identifiable event occurs only if and when your affirmative defense of the statute of limitations is upheld in a final judgment or decision in a judicial proceeding, and the period for appealing the judgment or decision has expired.
Code D — Foreclosure election. Code D is used to identify cancellation of debt when the creditor elects foreclosure remedies that statutorily end or bar the creditor's right to pursue collection of the debt. This event applies to a mortgage lender or holder who is barred from pursuing debt collection
after a power of sale in the mortgage or deed of trust is exercised.
Code E — Debt relief from probate or similar proceeding. Code E is used to identify cancellation of debt as a result of a probate court or similar legal proceeding.
Code F — By agreement. Code F is used to identify cancellation of debt as a result of an agreement between the creditor and the debtor to cancel the debt at less than full consideration.
Code G — Decision or policy to discontinue collection. Code G is used to identify cancellation of debt as a result of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. For purposes of this identifiable event, a defined policy includes both a written policy and the creditor's established business practice.
Code H — Expiration of nonpayment testing period. Code H is used to indicate that the creditor hasn't received a payment on the debt during a testing period ending on the tax year of the 1099-C. The testing period is a 36-month period increased by the number of months the creditor was prevented from engaging in collection activity by a stay in bankruptcy or similar bar under state or local law. This identifiable event applies only for a creditor that is a financial institution or credit union (and certain of their subsidiaries), the FDIC, the RTC, the NCUA, any other federal executive agencies, and any successor or subunit of the FDIC, the RTC, the NCUA, or a federal executive agency.Expiration of the nonpayment testing period doesn't necessarily result from an actual discharge of indebtedness.
Code I — Other actual discharge before identifiable event. Code I is used to identify an actual cancellation of debt that occurs before any of the identifiable events described in codes A through H.
Form 1099-C Reference Guide for Box 6 Identifiable Event Codes
A - Bankruptcy
B - Other judicial debt relief
C - Statute of limitations or expiration of deficiency period
D - Foreclosure election
E - Debt relief from probate or similar proceeding
F - By agreement
G - Decision or policy to discontinue collection
H - Expiration of nonpayment testing period
I - Other actual discharge before identifiable event
What do I do if I receive a Form 1099-C?
Filing form 982 with your tax return with a proper exception code will eliminate the extra tax caused by reporting 1099-C as income. The only other alternative is to report the income on page 1 of your form 1040 as income. Using form 982 can be difficult and you may want to consult a profession tax
preparer before you file this tax form on your own.
John Oliver does comic thorough show on the debt buyer and collection industry. The fact that a bank can write off debt and issue a 1099-C and then an unlicensed debt collector can still collect in full the debt is not right.
The IRS assumes income reported on form-1099-c is taxable unless specifically excluded by the taxpayer on a properly filed tax return.
Oliver dug into the seamy underbelly of the largely unregulated debt-buying industry, revealing how in many states, you can purchase and collect consumer debt with no license. To illustrate how ”disturbingly easy” it was to establish a debt-buying company, Oliver did just that, forming Central Asset Recovery Professionals, or CARP (after the bottom-feeding fish) in Mississippi via the internet.
Soon after CARP was formed, it was offered the chance to purchase $15 million in out-of-statute medical debt (meaning the debt was technically too old to be collectible under state law) for $60,000. CARP pulled the trigger, and along with the debt, acquired the names, current addresses and social security numbers of the nearly 9,000 debtors included in the portfolio, meaning Oliver was free to now pursue the owing parties in any way he saw fit.
Instead, Oliver chose to forgive the $15 million in debt, freeing 9,000 people from the threat of late-night phone calls and empty lawsuits, while simultaneously one-upping Oprah in the process by achieving the largest monetary giveaway in TV history. The full video can be seen above or on utube.
Visit the charity that facilitated John Oliver's $15 million giveaway. RIP Medical Debt.