Foreclosure ATG - Chapter 6 - Tax Consequences of Abandonments
Publication Date - February 2015
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
Abandonment is treated as an exchange of property when the owner gives up possession and use of the property voluntarily and permanently to the lender, with the intention of ending his/her ownership and does not pass it on to anyone else. Abandonment may lead to foreclosure proceedings in order for the lender to obtain legal possession of the property. Abandonment is different from a voluntary conveyance such as a deed in lieu of foreclosure. Generally, the lender and the homeowner enter into a deed in lieu of foreclosure agreement where the transaction is treated as an exchange of property to satisfy a debt.
Whether abandonment has occurred or not is determined by a review of all the facts and circumstances. Intent to abandon the property by affirmative acts should be considered to determine whether abandonment occurred. For example, permanently moving out and mailing the keys to the lender can be indicators of the intent to abandon the property. A lender is required to issue a Form 1099-A when the lender determines that property has been abandoned.
The tax consequences depend on whether the debt is recourse or nonrecourse. If the amount realized is more than the adjusted basis, then a gain is realized. If the adjusted basis is more than the amount realized, then a loss is realized. The character of the loss depends on the character of the property. For example, no loss is allowed for abandonment of a personal residence, but a loss from an abandoned business property, rental property, or investment property may be allowed.
If the debt is nonrecourse, a sale or exchange is reported in the year the property is abandoned. If the debt is recourse, then the gain/loss is not reported until the year that foreclosure sale is completed. The IRS has seen that the Form 1099-A may be issued several months or years after the taxpayer has actually abandoned the property. The disposition is not reported until the lender takes action on the property and possibly against the taxpayer within state law timeframes.
The court in George v. United States, 1996 WL 437532 (D. Colo. 1996), stated,
"[T]he worthlessness and abandonment arguments, however, are inapplicable to recourse debts as a matter of law. Property that secures a taxpayer's recourse obligation is not worthless prior to foreclosure. Commissioner v. Green, 126 F. 2d 70, 72 ( 3d Cir. 1942) ("where, as here, the taxpayer is liable for the debt, interest and taxes by virtue of the mortgage or the bond thereby secured, the property continues until foreclosure sale to have some value which, when determined by the sale, bears directly upon the extent of the owner's liability for a deficiency judgment.") Likewise, property that secures a taxpayer's recourse obligation may not be considered abandoned for purposes of a loss deduction prior to foreclosure. Daily v. Commissioner, 81 T.C. 161 (1983) (an attempt to abandon property subject to recourse debt does not result in a deductible loss), aff'd, Daily v. C.I.R., 742 F.2d 1461 (9th Cir. 1984); Middleton v. Commissioner, 77 T.C. 310, 323 (1981) ("at least one court has held that the abandonment of property subject to a recourse debt does not result in loss until the foreclosure sale because, since the possibility of deficiency exists, the amount of the loss cannot be fixed until the sale takes place."), aff'd, Middleton v. Commissioner, 693 F.2d 124 (11th Cir. 1982)."
Completion of a foreclosure is determined by state law. When the year of disposition is in question, examiners should seek advice from their local counsel to determine when a foreclosure is complete.
Example 32. In 2007, Diana purchased her principal residence for $200,000. She borrowed the entire purchase price through a recourse loan. In 2011, Diana's employer faced financial difficulties and reduced employees' salaries which caused a financial hardship on Diana and she was unable to meet her financial obligations. The loan balance on her home was $185,000 and the FMV declined from $250,000 to $150,000. Diana decided to abandon her home, moved her belongings out, and mailed the keys and garage door opener to the lender on August 1, 2011. The bank eventually foreclosed and sold the home in 2012 and issued a Form 1099-C.
Because Diana is personally liable for the debt, she does not report a gain or loss, or CODI in 2011 when she abandoned the home, but in 2012 when the disposition was completed. The affirmative acts taken by Diana by permanently moving out and mailing the keys to the lender indicate her intent to abandon the home, but the lender did not recognize the abandonment until 2012 when the lender foreclosed on the property.
Example 33. In 2005, Ruby purchased a second home for $315,000. She borrowed the entire purchase price through a nonrecourse loan. In 2011, the value of her property declined to $289,000 and she was able to obtain a loan modification. The lender forgave $26,000, the difference between the outstanding loan amount and the current FMV of the property. In 2012, Ruby was unable to make the monthly payments and abandoned the property. The lender did not become aware that the property was vacant until 2013 and issued a Form 1099-A. The lender eventually sold the property in a foreclosure sale in 2014.
Ruby does not meet any of the exclusions in IRC §108(a)(1). Therefore, she reported the entire $26,000 discharged debt as other income on line 21 of her 2011 Form 1040 tax return. Because Ruby was not personally liable for the note, she would report the disposition in 2013, when the lender released her from legal responsibility of the property and note.
As indicated in the examples above, the dispositions were reported in different years. In Example 32, the loan was recourse and the taxpayer was not required to report the disposition until the year that the foreclosure sale was complete. The sale determined the deficiency amount. In some cases, a lender may choose to forgive a portion or the entire amount of the deficiency. Depending on state law and the manner of foreclosure action taken, the taxpayer possibly would be responsible to pay back a portion or the entire deficiency balance once the lender obtains a deficiency judgment.
Since the loan was nonrecourse in Example 33, the disposition is reported in the year that the lender acknowledges that an abandonment occurred through the issuance of a Form 1099-A. Repossession of the property by the lender satisfied the debt.