Page 375 - TaxAdviser_2022

CASE STUDY
CASE STUDY

Tax consequences of

real property foreclosures

Editor: Owners of real property sometimes results differ depending on whether the
Patrick L. Young, CPA encounter difficult financial times due debt is recourse or nonrecourse. Under-
to an overall decline in the economy or standing the differences is a key factor in
events that adversely affect their particu- proper planning for the foreclosure.
lar area of the country. These conditions
may produce situations where an owner Recourse debt
does not have sufficient cash flow from a A foreclosure, or a deed in lieu of
property to meet the debt requirements, foreclosure, transaction may result in
or the property declines to a value that is COD income to the borrower when
less than the outstanding debt. In either recourse debt is involved. The taking of
case, foreclosure of the property by the property by the lender in satisfaction of
Real property lender is often the final outcome. a recourse debt is treated as a deemed
Real property foreclosures can
foreclosures can produce various tax consequences de- sale with proceeds equal to the lesser of
the property’s fair market value (FMV)
produce various pending on the type of debt (recourse at the time of foreclosure or the amount
tax consequences or nonrecourse), the taxpayer’s adjusted of secured debt. If the amount of debt
basis in the property, and the taxpayer’s exceeds FMV, the difference is treated as
depending on whether financial condition at the time of the COD income if it is forgiven (Regs. Sec.
the debt is recourse foreclosure. Proper planning both 1.1001-2(c), Example 8, and Rev. Rul.
or nonrecourse. before and after a foreclosure can help 90-16). (Note that Sec. 108 provides
minimize the tax consequences of
special mandatory relief provisions for
these transactions. COD income of certain bankrupt or
Note: There are special tax provi- insolvent taxpayers.)
sions (not covered in this column) for As a result of these rules, it is possible
cancellation-of-debt (COD) income on for a foreclosure transaction involving
principal residences. recourse debt to result in both (1) a gain
or loss from the sale of the property be-
Recourse and nonrecourse cause the property’s FMV is more or less
debt often produce different than basis and (2) COD income because
tax results the secured debt exceeds the property’s

A recourse debt enables the lender to FMV. The amount credited or received
pursue the individual borrower for the in a foreclosure sale determines the sales
balance due on a debt in addition to proceeds for computing gain or loss PHOTO BY COMSTOCK/STOCKBYTE/THINKSTOCK
This case study has been adapted foreclosing on the property. Conversely, (Aizawa, 29 F.3d 630 (9th Cir. 1994);
from Checkpoint Tax Planning and a nonrecourse debt is secured solely by Webb, T.C. Memo. 1995-486). The
Advisory Guide’s Sales and Exchanges
topic. Published by Thomson Reuters, the real property, thus shielding the in- character of the gain or loss depends on
Carrollton, Texas, 2022 (800-431-9025; dividual borrower from personal liability. the character of the property subject to
tax.thomsonreuters.com). When property is foreclosed, the tax the foreclosure.

44 July 2022 The Tax Adviser