Introduction to the FederalIncome Tax Issues ConcerningCancellation of Debt and theReporting Required When a

Taxpayer Receives Form 1099-Aand Form 1099-C

Written and Presented by

Paul LaMonaca, CPA, MST

Seminar materials and seminar presentations are intended to stimulate thought anddiscussion and to provide attendees with useful ideas and guidance in the areas of federaltaxation and administration. These materials as well as the comments of the instructors do notconstitute and should not be treated as tax advice regarding the use of any particular taxprocedure, tax planning technique or device or suggestion or any of the tax consequencesassociated with them.

Although the author has made every effort to ensure the accuracy of the materials and theseminar presentation, neither the author, the presenter nor the National Society of TaxProfessionals assumes any responsibility for any individual’s reliance on the written or oralinformation presented during the presentation. Each attendee should verify independently allstatements made in the materials and during the seminar presentation before applying them toa particular fact pattern and should determine independently the tax and other consequences ofusing any particular device, technique or suggestion before recommending the same to a clientor implementing the same on a client’s or on his or her own behalf.

Copyright © Paul LaMonaca 2015. All Rights Reserved.

Materials may not be copied or reprinted without prior written permission of PaulLaMonaca.

Table of Contents

Page

A. Comparison of IRS Forms 1099-A and 1099-C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B. Instructions for Form 1099-A “Acquisition or Abandonment of Secured Property” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

C. Instructions for Form 1099-C “Cancellation of Debt” . . . . . . . . . . . . . . . . . . . . . . . . . . 2

D. Abandonment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

E. Specific Instructions for Form 1099-C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

F. Debt Defined and When is it Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

G. §61(a)(12) and §108 Discharge of Indebtedness Issues . . . . . . . . . . . . . . . . . . . . . . . . . 8

H. Home Mortgage Debt Relief Expired After 12/31/2014 . . . . . . . . . . . . . . . . . . . . . . . . 11

Supplemental Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

• Tax Court Case: Taxpayer Liable for Cancellation of Debt Even Though1099-C Reports Otherwise

• IRS Form 1099-A Acquisition or Abandonment of Secured Property and Instructions

• IRS Form 1099-C Cancellation of Debt and Instructions

• IRS Publication 4681 Cancelled Debts, Foreclosures, Repossessions and Abandonments (for Individuals)

Recommended IRS Publications:

• 544 Sales and Other Dispositions of Assets

• 551 Basis of Assets

• 908 Bankruptcy Tax Guide

• 982 Reduction of Tax Attributes Due to Discharge of Indebtedness(And Section 1082 Basis Adjustment)

1

A. Comparison of IRS Forms 1099-A and 1099-C

1. There is much confusion over the reporting requirements concerning the

issuing and receiving of IRS Form 1099-A “Acquisition or Abandonment of

Secured Property” and IRS Form 1099-C “Cancellation of Debt.” The

information reported on these two forms are very similar and there is where

the confusion begins.

2. On Form 1099-A, the LENDER is required to report their identifying

information such as name, street address, city, state, zip code and telephone

number and foreign postal code if applicable along with their federal

identification number. In addition, the Form 1099-A requires the

BORROWER’S identification number as well as the other identifying

information which includes the name, street address, city, state, zip code or

foreign postal code as well as the account number of the BORROWER.

3. On the Form 1099-C the CREDITOR’S name, address and federal

identification number is required as is all of the identifying information about

the DEBTOR, including identification number, name, address etc. and the

account number.

B. Instructions for Form 1099-A “Acquisition or Abandonment of Secured

Property”

1. Form 1099-A, Box 1 is titled “Date of lender’s acquisition or knowledge of

abandonment.” Therefore it reports a lender’s acquisition of property that was

security for a loan and the date is generally the earlier of:

a. the date title was transferred to the lender, or

b. the date possession and the burdens and benefits of ownership were

transferred to the lender.

Tax Professional Note: This date may be the date of the foreclosure or

execution sale or the date the taxpayer’s right of redemption or objection

expired.

2. If the taxpayer abandoned the property then the date shown is the date on

which the lender first knew or had reason to know that the property was

abandoned or the date of foreclosure, execution, or similar sale.

3. Form 1099-A, Box 2 reports “Balance of Principal Outstanding” which is the

debt owed to the lender on the loan when:

2

a. the interest in the property was acquired by the lender or

b. on the date the lender first knew or had reason to know that the

property was abandoned.

4. Box 3 of Form 1099-A is blank.

5. Box 4 reports the “Fair Market Value of the Property” (FMV). If the FMV

amount in Box 4 is less than the “Balance of Principal Outstanding” in Box 2

and the debt is actually cancelled, then the taxpayer may have cancellation of

debt income.

Tax Professional Note: The instructions for Box 4 of Form 1099-A state that

if the property of issue is the taxpayer’s principal residence then IRS

Publication 523 “Selling Your Home” should be reviewed in order to

determine any taxable gain or ordinary income on the foreclosure or

abandonment. (There are issues concerning the exclusion of gain under the

provisions of §121.)

6. Box 5 requires that the LENDER check the box if the BORROWER was

personally liable for repayment of the debt when the debt was created or, if

modified after the creation when it was last modified.

7. Box 6 reports the “Description of the Property” acquired by the LENDER or

abandoned by the BORROWER.

C. Instructions for Form 1099-C “Cancellation of Debt”

1. Form 1099-C requires that the CREDITOR’S name, street address, etc.

including telephone number be included as well as the CREDITOR’S federal

identification number. It also includes the DEBTOR’S identification number,

name, street address, etc. The CREDITOR also is required to report an

account number or other unique number assigned to distinguish the

DEBTOR’S account.

2. The general instructions on Form 1099-C state that the DEBTOR receives the

document because a Federal Government agency or an applicable financial

entity (CREDITOR) has discharged (either through cancellation or

forgiveness) a debt that the DEBTOR owed or because an identifiable event

occurred that either is or is deemed to be a discharge of a debt of $600 or

more.

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Tax Professional Note: If a CREDITOR has discharged a debt that the

taxpayer owed, then the taxpayer is required to include the discharged amount

in gross income even if less than $600 on the “Other Income” line of Form

1040.

3. The instructions further state that the taxpayer may not have to include all of

the cancelled debt in income if they qualify for any of the exceptions and

exclusions under the law for situations such as bankruptcy and insolvency in

which the instructions refer the taxpayer to IRS Publication 4681, “Cancelled

Debts, Foreclosures, Repossessions and Abandonments.”

4. In addition, the instructions state that if an identifiable event has occurred but

the debt has not actually been discharged then the taxpayer should include any

discharged debt in income in the year that it is actually discharged unless an

exception or exclusion applies in that tax year.

5. Box 1 reports the date the earliest identifiable event occurred, or at the

CREDITOR’S discretion, the date of an actual discharge that occurred before

an identifiable event. The instruction refers the taxpayer to an “event code”

in Box 6 of Form 1099-C which is discussed later under the information for

Box 6.

6. Box 2 reports the “amount of debt discharged” which is the amount of debt

either actually or deemed discharged. The instructions provide a note to the

taxpayer which states if the taxpayer does not agree with the amount, then they

should contact the CREDITOR.

7. Box 3 reports “interest if included in Box 2.” This amount may or may not

have to be reported in gross income and will be discussed later.

8. Box 4 reports “debt description” and states that if Box 7 (Fair Market Value

of Property) is completed then Box 4 also reports a description of the property.

9. Box 5 reports “If checked, the DEBTOR was personally liable for the

repayment of the debt.” This box would be checked if the taxpayer was

personably liable for the debt when the debt was created or, if modified, at the

time of the last modification and refers to IRS Publication 4681 “Cancelled

Debts, Foreclosures, Repossessions and Abandonments.

10. Box 6 reports an “Identifiable Event Code” mentioned n Box 1 above. It is the

reason the CREDITOR filed the form. The codes in Box 6 are described in

more detail in Pub. 4681. The Codes are as follows:

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A - Bankruptcy;

B - Other judicial debt relief;

C - Statute of limitations expiration of deficiency period;

D - Foreclosure election;

E - Debt relief from probable or similar proceedings;

F - By agreement;

G - Decision or policy to discontinue collection;

H - Expiration of nonpayment testing period, or

I - Other actual discharge before identifiable event.

11. Box 7 reports “Fair market value of property” (FMV). If, in the same calendar

year, a foreclosure or abandonment of property occurred in connection with

the cancellation of the debt then the FMV of the property will be shown, or the

taxpayer will receive a separate Form 1099-A. Generally, the gross

foreclosure bid price is considered to be the FMV.

12. For an abandonment or voluntary conveyance in lieu of foreclosure, the FMV

is generally the appraised value of the property. The taxpayer may have

income or loss due to the acquisition of the property by the LENDER or the

abandonment of the property by the BORROWER.

13. The IRS instructions for Forms 1099-A and 1099-C are included in the same

physical document. The specific instructions for Form 1099-A state that the

issuer should file the form for each BORROWER if:

a. the issuer lends money in connection with their trade or business and,

b. in full or partial satisfaction of the debt, the issuer acquires an interest

in property that is security for the debt, or has reason to know that the

property has been abandoned.

• It further states that the issuer need not be in the business of lending

money to be subject to this reporting requirement.

14. The instructions also introduce the issue of coordination with Form 1099-C

and states that if, in the same calendar year, the issuer cancels a debt of $600

or more in connection with a foreclosure or abandonment of secured property,

then it is not necessary to file both Form 1099-A and Form 1099-C. The

instructions state that the issuer may file Form 1099-C only and states that the

issuer will meet their 1099-A filing requirement for the debtor by completing

Boxes 4, 5 and 7 on Form 1099-C. It also states that if the issuer files both

Forms 1099-A and 1099-C then they do not complete Boxes 4, 5 or 7 on

Form 1099-C.

5

15. According to the instructions for Form 1099-A, “property” is defined as

meaning any:

a. real property (such as a personal residence),

b. intangible property, and

c. personal property.

16. However, the instructions state that there are reporting exceptions and no

reporting is required for tangible personal property (such as a car) held only

for personal use. However, the lender is required to file the Form 1099-A if

the property is totally or partially held for use in a trade or business or for

investment.

17. Also, no reporting is required if the property that is securing the loan is located

outside the United States and the borrower has furnished the lender a

statement, under penalties of perjury, that the borrower is an exempt foreign

person (unless the lender knows the statement is false).

D. Abandonment

1. The instructions for Form 1099-A also discuss the issues dealing with an

abandonment of a property. An abandonment occurs when the objective facts

and circumstances indicate that the borrower intended to an has permanently

discarded the property from use.

2. The lender has “reason to know” of an abandonment based on all the facts and

circumstances concerning the status of the property. The lender will be

deemed to know all the information that would have been discovered through

a reasonable inquiry when, in the ordinary course of business the lender

becomes aware or should become aware of circumstances indicating that the

property has been abandoned.

3. If the lender expects to commence a foreclosure execution, or similar sale

within 3 months of the date and had reason to know that the property was

abandoned, then reporting is required as of the date the lender acquires an

interest in the property or a third party purchases the property at such sale. If

the lender expects to but does not commence such action within 3 months, then

the reporting requirement arises at the end of the 3-month period.

6

E. Specific Instructions for Form 1099-C

1. The issuer of a 1099-C is required to file the form for each debtor for whom

the issuer cancelled a debt owed to them of $600 or more if they are a specific

entity listed in the instructions and an identifiable event has occurred. It does

not matter whether the actual cancellation is on or before the date of the

identifiable event.

Tax Professional Note: The instructions state that the Form 1099-C must be

filed regardless of whether the debtor is required to report the debt as income.

The debtor may be an individual, corporation, trust, estate, association or

company.

2. The instructions discuss the coordination with Form 1099-A and state that if

in the same calendar year, the creditor cancels a debt of $600 or more in

connection with a foreclosure or abandonment of secured property then it is

not necessary to file both forms to the same debtor.

3. The instructions also state that the creditor can file just the Form 1099-C and

that they will meet the Form 1099-A filing requirement for the debtor by

completing Boxes 4, 5 and 7 on Form 1099-C. The creditor may file both but

should not complete Box 4, 5 and 7 on Form 1099-C.

F. Debt Defined and When is it Cancelled

1. A debt is any amount owed including stated principal, stated interest, fees,

penalties, administrative costs and fines. The amount of debt cancelled may

be all or only part of the total amount owed. However, for a lending

transaction, the creditor required to report only the stated principal.

2. A debt is deemed cancelled on the date an identifiable event occurs, or, if

earlier, the date of the actual discharge if the creditor chooses to file Form

1099-C for the year of cancellation. An identifiable event is one of the

following:

a. A discharge in bankruptcy under Tile 11 of the U.S. Code. There are

certain discharges in bankruptcy not required to be reported described

under Exception in the instructions of Form 1099-C. Enter “A” in Box

6 to report this identifiable event.

b. A cancellation or extinguishment making the debt unenforceable in a

receivership, foreclosure or similar federal nonbankruptcy or state court

proceeding. Enter “B” in Box 6 to report this identifiable event.

7

c. A cancellation or extinguishment 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.

Expiration of the statute of limitations is an identifiable event only

when a debtor’s affirmative statute of limitations defense is upheld in

a final judgment or decision of a court and the appeal period has

expired. Enter “C” in Box 6 to report this identifiable event.

d. A cancellation or extinguishment when the creditor elects foreclosure

remedies that by law extinguish or bar the creditor’s right to collect the

debt. This event applies to a mortgage lender or holder who is barred

by local law from pursuing debt collection after a “power of sale” in

the mortgage or deed of trust is exercised. Enter “D” in Box 6 to report

this identifiable event.

e. A cancellation or extinguishment making the debt unenforceable under

a probate or similar proceeding. Enter “E” in Box 6 to report this

identifiable event.

f. A discharge of indebtedness under an agreement between the creditor

and the debtor to cancel the debt at less than full consideration (for

example, short sales). Enter “F” in Box 6 to report this identifiable

event.

g. A discharge of indebtedness because of a decision or a defined policy

of the creditor to discontinue collection activity and cancel the debt.

A creditor’s defined policy can be in writing or an established business

practice of the creditor. A creditor’s established practice to stop

collection activity and abandon a debt when a particular nonpayment

period expires is a defined policy. Enter “G” in Box 6 to report this

identifiable event.

h. The expiration of non-payment testing period discussed in the Form

1099-C instructions. This event occurs when the creditor has not

received a payment on the debt during the testing period. The testing

period is a 36-month period ending on December 31, plus any time

when the creditor was precluded from collection activity by a stay in

bankruptcy or similar bar under state or local law. Enter “H” in Box

6 to report this identifiable event.

Tax Professional Note: The creditor can rebut the occurrence of this

identifiable event if:

8

(a) the creditor (or a third party collection agency on behalf of the

creditor) has engaged in significant bona fide collection activity

during the 12-month period ending on December 31, or

(b) Facts and circumstances that exist on January 31 following the

end of the 36-month period indicate that the debt was not

cancelled.

Significant bona fide collection activity does not include nominal or

ministerial collection action, such as an automated mailing. Facts and

circumstances indicating that a debt was not cancelled include the

existence of a lien relating to the debt (up to the value of the security)

or the sale or packaging for sale of the debt by the creditor.

i. Other actual discharge before identifiable event. Enter “I" in Box 6 if

there is another actual discharge before one of the identifiable events

listed above.

G. §61(a)(12) and §108 Discharge of Indebtedness Issues

1. §61(a) provides a general rule that gross income means all income from

whatever source derived unless there is a specific exception, exemption or

exclusion. Specifically, §61(a)(12) provides in general that gross income

includes income from the discharge of indebtedness, and §108 discusses the

specifics of “income from discharge of indebtedness.”

2. For purposes of this discussion §108(a)(1) provides that gross income does not

include any amount of the indebtedness if the taxpayer is:

a. bankrupt under a Title 11 case,

b. the discharge takes place when the taxpayer is insolvent,

c. the indebtedness discharged is qualified farm indebtedness,

d. the indebtedness is qualified real property business indebtedness, or

e. the debt is qualified principal residence indebtedness.

3. Publication 4681: Cancelled Debts, Foreclosures, Repossessions and

Abandonments addresses how to report the forgiveness of debt and how and

when the §108(a)(1) exceptions to inclusion to gross income are permitted.

Part 3 of Publication 4681 addresses “Abandonments.” This section

discusses the tax consequences of abandoning property subject to tax.

9

4. Generally when there is forgiveness of debt for $600 or more the entity that

forgives the debt should issue IRS Form 1099-C Cancellation of Debt and the

amount of debt is reported in Box 2. Unless the taxpayer meets an exception

or exclusion, the cancelled debt is ordinary income includible in the current

year’s tax return.

Tax Professional Reminder: Even if the taxpayer did not receive a Form

1099-C the cancelled debt must be reported as gross income in the current

year unless one of the exceptions or exclusions to the general inclusion rule

applies.

5. In the situations where a IRS Form 1099-C is not issued to the taxpayer, there

is still debt forgiveness which must be reported. In many cases an IRS Form

1099-A Acquisition or Abandonment of Secured Property is issued and IRS

Form 1099-C is never issued. In this situation there has been debt forgiveness

and it must be reported. The reporting depends on whether or not the debt

forgiven is recourse or nonrecourse.

6. Recourse debt is defined as debt for which the taxpayer is personally liable

even if the proceeds from the disposition of the property are not enough to

satisfy the amount owed.

7. Nonrecourse debt is defined as debt for which taxpayer is not personally liable

beyond the amount realized on the disposition of the property. If the taxpayer

is not personally liable for the debt then there is no ordinary income from the

cancellation of the debt unless the taxpayer retains the property and either:

a. the lender offers a discount for early payment of the debt, or

b. the lender agrees to a loan modification that results in the reduction of

the principal balance of the debt.

EXAMPLE #1: Don owned a rental property that had a cost basis of $395,571

and accumulated depreciation of $83,297 resulting in an adjusted basis of $312,274.

The property was foreclosed and repossessed and the creditor issued IRS Form 1099-

C. The bank stated that the Box 1 date of the creditor’s identifiable event was

8/10/15 and the Box 2 Amount of Debt Discharged was $163,214. The outstanding

debt immediately before the foreclosure was $478,401. The Box 4 Fair Market Value

was $315,187 which was the price for which it was sold by the bank. Box 5 reported

that Don was personally liable for repayment of the debt, therefore his debt is

recourse debt. The abandonment or foreclosure is a deemed sale of the property

requiring Don to report a disposition on IRS Form 4797.

10

Don must first determine his ordinary income as follows:

Outstanding Debt Before the Transfer $478,401

Less: FMV of Property Transferred (Box 4) (315,187)

Ordinary Income from the Cancellation of Debt (Box 2) $163,214

Don must then calculate any gain or loss on the foreclosure or

repossession as follows:

Fair Market Value (Box 4) $315,187

Less: Adjusted Basis of Property (312,274)

Gain or Loss on Foreclosure or Repossession $ 2,446

As a result Don has two separate transactions with the first resulting inordinary income of $163,214 and the second resulting in a capital gainof $2,446. The recognition of the capital gain will generate §1250unrecaptured depreciation subject to a maximum long-term capital gainrate of 25%.

The ordinary income is required to be reported on Schedule E as rentalincome. However, Don may be able to exclude some or all of theordinary income by reviewing IRS Form 982 to see if he satisfies anyof the exceptions or exclusions under §108(a)(1).

EXAMPLE #2: Don owned a rental property with a cost of $75,000

and accumulated depreciation of $60,000 resulting in an adjusted basis

of $15,000. The property was foreclosed and repossessed and the

lender issued IRS Form 1099-A. The Box 1 date was 8/10/15 and the

Box 2 Balance of Principal Outstanding was $147,029 and the Box 4

FMV was $62,000. Box 5 reported that Don was not personally liable

for the repayment of the debt meaning that the debt was nonrecourse

debt.

When reviewing Table 1-1 in IRS Publication 4681, Part I, the

ordinary income calculation is not required to be completed if the

taxpayer is not personally liable for the debt. Therefore, Don is only

required to calculate the gain or loss on the foreclosure and

repossession where he is required to report the amount of outstanding

debt from Box 2. He calculates a gain as follows:

Outstanding Debt (Amount Realized) $147,029

Less: Adjusted Basis ( 15,000)

Gain on Foreclosure or Repossession $132,029

11

The transaction is reported o IRS Form 4797, Page 2, Part III. Don

will include $60,000 of the $132,029 as §1250 Unrecaptured

Depreciation subject to a maximum capital gain rate of 25% and the

balance will be the appreciation includible as a long term capital gain

with a maximum rate of 15% or 20% depending on his ordinary tax

bracket threshold amount.

H. Home Mortgage Debt Relief Scheduled to Expire After 12/31/2016

1. §108(a)(1)(E) provides that principal residence debt discharged on

or after January 1, 2007 and before January 1, 2017, is excluded

from gross income.

2. The law provides that gross income does not include any discharge of qualified principal residence indebtedness. A taxpayer can exclude up to $2 million of mortgage debt forgiveness on their principal residence.

Tax Professional Note: The Committee report states that this exclusion applies whether there is a restructure of debt or the

taxpayer loses the residence in a foreclosure.

EXAMPLE #1: Before the 2007 Mortgage Relief Act, there were no special rules applicable to discharge of indebtedness of acquisition

debt on a taxpayer’s principal residence, Don was not in bankruptcy and was not insolvent and had a property subject to a $200,000 mortgage debt for which he was personal liability. The creditor foreclosed and the home was sold for $180,000 in satisfaction of the debt. As a result Don had $20,000 of discharge of indebtedness which was included in ordinary income. The result would have been the same if the creditor had also restructured the loan and reduced the debt to $180,000.

EXAMPLE #2: As a result of the 2007 Mortgage Relief Act Don does not have to include the $20,000 in income because of the exclusion rule. The result would be the same whether the creditor restructures the loan and reduces the principal amount to $180,000 or forecloses on the property and satisfies the $200,000 debt with a$180,000 transaction.

3. §108(h)(4) provides that if any loan is discharged, in whole or in part, and only part of the loan is qualified principal residence indebtedness, then the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before the discharge) which is not qualified principal residence indebtedness.

12

EXAMPLE #3: Don’s principal residence is secured by a debt of$600,000, of which $400,000 is qualified principal residenceindebtedness. If Don’s residence is sold for $300,000 and $300,000 of

debt is discharged, only $100,000 of the debt discharged may beexcluded as follows:

Total Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $600,000

Qualified Principal Residence Debt . . . . . . . . . . . . . . . . . (400,000)

Nonqualified Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $200,000

Total Debt Forgiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . (300,000)

Exclusion for Home Mortgage Debt Relief . . . . . . . . . . . $(100,000)

The remaining $200,000 of nonqualified debt may qualify in whole orin part for one of the other exclusions (e.g., the insolvency exclusion).

Don must report the transaction on IRS Form 982 Reduction of Tax

Attributes Due to Discharge of Indebtedness (and Section 1082 Basis

Adjustments). Don will also be issued IRS Form 1099-C Cancellation

of Debt by the Creditor by no later than January 31 following the yearof debt forgiveness.

4. §108(h)(2) provides that qualified principal residence indebtedness is

acquisition indebtedness under §163(h)(3)(B) with respect to the

taxpayer’s principal residence, with a $2 million limit ($1 million for

married individuals filing separately).

5. §108(h)(5) provides that “principal residence” has the same meaning

as under the home sale exclusion rules of §121.

Tax Professional Reminder: Acquisition indebtedness of a principal

residence is indebtedness incurred in the acquisition, construction, or

substantial improvement of an individuals’ principal residence that is

secured by the residence. It includes refinancing of debt to the extent

the amount of the refinancing does not exceed the amount of the

refinanced indebtedness. (Joint Committee on Taxation JCX-86-07)

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6. §108(h)(1) provides that the basis of the taxpayer’s principal residence

is reduced by the excluded amount, but not below zero.

TAX PROFESSIONAL ALERT: The mortgage forgiveness

exclusion only applies with respect to a taxpayer’s principal residence

only. Therefore, while interest for a taxpayer’s second home may be

deductible, debt forgiven with respect to a taxpayer’s second home is

not excludible.

7. §108(a)(2) provides that an insolvent taxpayer (other than one in a Title

11 bankruptcy) can elect to have the mortgage forgiveness exclusion

not apply and can instead rely on the §108(a)(1)(B) exclusion for

insolvent taxpayers.

8. If there is a gain on the foreclosure of a principal residence then it may

be partially or completely excluded from gross income under theprovisions of §121.

9. If the taxpayer did not qualify for the 2-out-of-5 year ownership and

use test then one could still qualify for the partial exclusion due to achange in employment, health or “unforeseen circumstances.” Reg.§1.121-3 states that safe-harbor events such as an involuntaryconversion, job loss, and events identified by the IRS as “unforeseencircumstances.”

10. The law requires that IRS Form 982 be attached to the taxpayer’s

return if any debt forgiven is excluded from income.

11. Most taxpayers who are affected by this exclusion rule will be requiredto fill out only a few lines on Form 982. In Part I under GeneralInformation a taxpayer will:

a. check box 1(e) which is Discharge of Qualified PrincipalResidence Indebtedness,

b. enter on line 2 total amount of discharged indebtedness

excluded from gross income, and

c. enter on line 10b the amount applied to reduce the basis of theprincipal residence.

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12. The instructions in Form 982 alert taxpayers that debt discharge underTitle 11 bankruptcy cannot be treated as a discharge of qualifiedresidence indebtedness and should follow the instructions fornonbusiness debt and check box 1a. Also, if the taxpayer is insolvent

then the taxpayer can elect to follow the insolvency rules and checkbox 1b and follow the Form 982 instructions for a nonbusiness debt.

13. Lenders are required to issue IRS Form 1099-C by January 31following the year of debt forgiveness for taxpayers whose debt wasreduced or eliminated.

14. The Form 1099-C must report the amount of debt forgiven and the fairmarket value (FMV) of any property given up through foreclosure.The IRS states that the taxpayers review the form carefully and notifythe lender immediately if any of the information reported is incorrectand cautions that special attention should be paid to the amount of debtforgiven in Box 2 and the FMV in Box 7.

15. The most difficult issue that the taxpayer faces is the FMV at the timethe debt is discharged. Generally FMV is the price at which theproperty is sold or if no sale takes place, a willing buyer and willingseller would agree to a given price where neither is under any pressureto buy or sell and are aware of all the facts surrounding the conditionof the property.

16. In a situation where the taxpayer has to surrender the property to thecreditor in an exchange for a cancellation of debt, the taxpayer may notagree with the FMV reported on the Form 1099-C. In thiscircumstance if the taxpayer could afford a professional appraisal of theproperty prior to the transfer of the property then this may be a bettercourse of action in order to determine the proper FMV.

Tax Professional Research Recommendation: IRS Publication 4681

Cancelled Debts, Foreclosures Repossessions and Abandonments.

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Supplemental Materials

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Taxpayer Liable for Cancellation of Debt Even Though 1099-C Reports Otherwise

Donald L. Dunnigan v. Commissioner, T.C. Memo 2015-190 §61 and §108 (9/28/2015)

Summary of the Case:

A taxpayer operated an appraisal business (Dunnigan Appraisal) as a sole

proprietorship and obtained a line of credit for it from Swift Financial. The Swift

agreement provided that Dunnigan was liable for the debt both individually and on

behalf of Dunnigan Appraisal.

In 2009, after receiving about $50,000 from the line of credit, Dunnigan negotiated

with Swift to settle the debt for $15,628. Swift filed a Form 1099-C (Cancellation

of Debt) reporting Cancellation of Debt (COD) income of $34,369.24 and indicating

(in Box 5) that Dunnigan was not personally liable for the debt. As a result Dunnigan

did not report the COD income on his 2009 return, but provided a note explaining that

the COD was not taxable because, as indicated on the Form 1099-C, Swift was not

holding him personally liable for the debt.

The Tax Court disagreed. In direct opposition to the Form 1099-C, the Swiftagreement provided that Dunnigan was individually liable for the debt, therefore, hehad COD income.

NOTE: Dunnigan represented himself in Tax Court, (Pro se).

Details of Case:

1. Petitioner was an appraiser and the sole proprietor of Donald Dunnigan Period

House Appraisal (Dunnigan Appraisal). In 2008 Dunnigan Appraisal was in

need of cashflow, and obtained a business line of credit for $50,000 from

Swift with respect to Dunnigan Appraisal.

2. The credit agreement that Swift drafted for Dunnigan Appraisal provided that

both parties were jointly and severally liable to pay all loans and all other

debts, obligations and liabilities of every kind and description, arising out of

all account transactions authorized by Dunnigan.

3. Over time he received approximately $50,000 from the Swift line of credit,

which he used to pay obligations of Dunnigan Appraisal. In 2009 he was

unable to pay back the borrowed funds in full, and he negotiated with Swift to

pay $15,628 in settlement of the debt Swift later reported on Form 1099-C,

Cancellation of Debt, that it had cancelled the debt of $34,369.24 on

September 28, 2009. It further indicated in Box 5 of Form 1099-C that

Dunnigan was not personally liable for repayment of the debt.

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4. Dunnigan and his wife filed for a legal separation in 2009 but were not

divorced that year. His wife subsequently filed her 2009 individual income

tax return with a filing status of “married filing separately.”

5. Dunnigan filed his 2009 return with a filing status of “single.” He also

reported a total of $68,360.95 of cancellation of debt income that consisted of

three discharges of indebtedness from entities other than Swift. He did,

however, include with his return a copy of the Form 1099-C issued by Swift

and handwrote on it the following:

PLEASE NOTE: SWIFT FINANCIAL INDICATED TO ME

THAT I AM NOT LIABLE FOR REPAYMENT OF

CANCELLED DEBT. I HAD EXPLAINED TO THEM THAT

I HAVE A SERIOUS CANCER PROBLEM, AND THAT I’M

76 YEARS OLD. THUS, THEY MARKED BOX 5 ‘NO.’

THE LOCAL IRS OFFICE SUGGESTED I EXPLAIN THE

SITUATION AT TIME OF FILING, AND FELT IT WOULD

LIKELY COME UNDER ‘HARDSHIP’ RULES FOR

APPROVAL.

Opinion of Tax Court

1. The issue remaining for decision is whether he had discharge of indebtedness

income from Swift for 2009. Income from discharge of indebtedness (also

called cancellation of debt) is included in the general definition of gross

income under §61(a)(12). The concept of discharge of indebtedness income

is that a taxpayer has realized an accession to income to the extent that he has

been released from indebtedness because assets previously offset by the

liability arising from the indebtedness have been freed. Cozzi v.

Commissioner, 88 T.C. 435, 445 (1987) (citing United States v. Kirby Lumber

Co., 284 U.S. 1 [10 AFTR 458] (1931).

2. Dunnigan testified that he received the income from the Swift line of credit,

and the Court stressed that the burden of proof lies with the taxpayer to show

why the discharge of indebtedness income should not be taxable. (Rule

142(a)).

3. He first argues that Swift did not hold him personally liable for the repayment

of the debt and it indicated this result on Box 5 of Form 1099-C. Cancellation

of debt income, however, may be realized without a taxpayer’s personal

liability for a debt. See, e.g., Gershkowitz v. Commissioner, 88 T.C. 984,

1006 (1987) (determining that taxpayers realized cancellation of debt income

where a creditor discharged their nonrecourse loans in exchange for cash

settlements). Dunnigan did not establish that he had no obligation to repay the

borrowed funds. Swift’s credit agreement with him and Dunnigan Appraisal

provided that he was individually and severally liable for repayment of the

credit line, in direct opposition to the Box 5 indication.

4. Dunnigan alleges that Swift and IRS employees told him that “hardship” rules

could apply in his case. However, he does not point to any legal authority that

addresses a “hardship” exception to the taxability of discharge of indebtedness

income. While there are exceptions to the recognition of such income under

§108(a) for cases of bankruptcy and insolvency, but the record does not show

that petitioner was either bankrupt or insolvent in 2009.

5. His reliance on alleged statements of Swift and IRS employees is also

unpersuasive. A trial before the Court is a proceeding de novo, and our

redetermination of a taxpayer’s tax liability is based on the merits and not on

any matters occurring before the notice of deficiency was sent. Greenberg’s

Express, Inc. v. Commissioner, 62 T.C. 324, 327-328 (1974). Additionally,

administrative guidance by the IRS is not binding on the Government, nor can

it change the plain meaning of tax statutes. See Miller v. Commissioner, 114

T.C. 184, 195 (2000) (addressing specifically IRS publications), aff’d sub

nom. Lovejoy v. Commissioner, 293 F.3d 1208 [89 AFTR 2d 2002-2989]

(10th Cir. 2002).

• While the Court did not doubt that Dunnigan experienced hardship, it was not

of a kind that controlled in this matter. He received approximately $50,000 in

2009, paid back approximately $15,000 and when his debt was discharged by

Swift. Dunnigan had an accession of income because he did not have to pay

back the remainder. That income is taxable.

• In reaching the decision the Tax Court considered all arguments made, and to

the extent not mentioned they concluded that they were moot, irrelevant or

without merit.