Question: James received a Form 1099-C, Cancellation of Debt, reporting a foreclosure on his rental property. The date in Box 1 is Feb. 3, 2022. Box 2 shows the amount discharged is $41,000. Box 5 is checked “yes,” indicating he was personally liable for repayment of the debt. Box 6 has Code G (decision or policy to discontinue collection) and the fair market value (FMV) in Box 7 is $19,000. James’s basis in the rental property is $25,000. How does he report the information from Form 1099-C on his tax return?
Answer: James will report two transactions: A sale and canceled debt income. Foreclosures are reported as a sale of the property. Since James is personally liable for repayment of the debt (recourse debt), the sales price is the FMV (Box 7).
James will report the sale on Form 4797, Sale of Business Property. The net profit or loss from the transfer of the rental property is determined by subtracting the cost basis or purchase price less depreciation from the sales price.
Next, you must determine if James has taxable or excludable canceled debt by verifying whether he is insolvent or solvent. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, includes an insolvency worksheet that can be used to determine whether a taxpayer is insolvent. James can exclude the canceled debt from gross income to the extent he’s insolvent. The amount of excludable canceled debt is reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and reduces the taxpayer’s tax attributes. The tax attribution reductions will apply Jan. 1 of the year following the year of debt cancellation. However, if James is solvent, the canceled debt is reported on Schedule E as rental income in the year it’s canceled. This treatment applies because the income is reported on the form the cancellation pertains to.
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Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing.