Basis required in year of discharge. This Tax Court case highlights the case of Richard Hussey, who purchased investment properties in 2009. To do so, he assumed approximately $1.7 million in outstanding loans. He sold 16 of the properties in 2012 and another seven in 2013, all but one at a loss. Hussey’s debt was modified following the 2012 sales, and he received a Form 1099-C, Cancellation of Debt, for each property he sold at a loss in 2012. The total amount of the debt discharged indicated on the Forms 1099-C was $754,054. After the 2013 sales, Hussy asked the bank for another modification of the remaining debt. The bank charged off $529,665 and indicated in its records that any payments received up to that amount would be posted as a loan loss reserve recovery. The bank did not issue any Forms 1099-C to Hussey for 2013. Basis required in year of discharge.

Hussey’s accountant prepared his form 1040 for 2012, showed that the properties had been sold at a gain of approximately $84,000. Due to the complexity of the return, the CPA referred Hussey to a Tax Attorney, who amended his form 1040 for 2012 and prepared the 2012 and 2014 returns, which showed a total loss of $613,263 The discharge of indebtedness generally results in an inclusion of gross income to the taxpayer on form 1099-C. However, Sec. 108(a)(1)(D) provides an exclusion for the discharge of QRPBI. The amount that can be excluded may not exceed the QRPBI’s outstanding principal amount, the property’s fair market value less any other QRPBI outstanding principal secured by the property. In addition, the discharge must satisfy the basis aggregation rule.

The Tax Court found that if the property is sold in the same year as the discharge, the basis adjustment must be made in the year the property is sold. Hussey was found not liable for an accuracy related penalty, as he had taken steps to make sure the returns were correct. If you have complex tax returns, call a Tax Resolution firm.