Academic journal article Journal of Accountancy
Taxation of Abandonments, Foreclosures and Repossessions: Many Taxpayers in the Current Economy Have Had Trouble Paying Mortgages, Car Notes and Other Debts. Some Are Forced to Abandon Property, Go through Foreclosures or Have Property Repossessed. While Such Measures May Alleviate the Financial Burden on These Taxpayers, the Tax Consequences Often Are Overlooked
When property that secures a debt is abandoned by voluntary or involuntary action, the tax consequence depends, among other things, on whether the taxpayer was personally liable for the debt and whether the abandoned property was personal use.
PROPERTY SECURED BY RECOURSE DEBT
If the debtor is personally liable for the loan on the property being abandoned, the loan is a recourse debt, and until foreclosure or repossession procedures are completed, there are no tax consequences, whether the property is personal use or business use. The foreclosure or repossession is treated as a sale, and the debtor may realize a gain or loss on the deemed sale. The amount realized is the lower of the asset's fair market value on the date of abandonment or the outstanding debt immediately before the transfer, reduced by any amount for which the taxpayer remains personally liable after the transfer. The amount realized also includes any proceeds the debtor received from the foreclosure sale. The amount realized is compared with the debtor's basis in the property to determine gain or loss.
Gain from a foreclosure sale of abandoned property is includible in gross income whether or not the taxpayer used the property for business purposes. However, losses from personal-use property are nondeductible. If the property is a business-use asset, the gain or loss on disposition is either a capital or an ordinary gain or loss, depending on the character and nature of the asset. After the foreclosure has been completed, if the financial institution or creditor forgives the debtor any part of the debt, the forgiven portion is cancellation of debt (COD) income and may be includible in the debtor's gross income. It is reported separately from any gain or loss realized from the sale.
PROPERTY SECURED BY NONRECOURSE DEBT
If the debtor is not personally liable for the debt (nonrecourse debt) and abandons personal-use property, such as a home or an automobile, the abandonment is treated as a sale in the year of abandonment. The amount realized on the sale--the outstanding loan balance--is compared with the taxpayer's adjusted basis in the property to determine gain or loss. …