Tax help for rental property debt cancellation
Posted May 19th, 2010 by adminInvestors who have multiple rental properties and experience a debt cancellation relating to a rental property might be missing an important tax break.
Tax return preparers and individuals who use tax return preparation software or (God forbid!) prepare their income tax returns by hand usually report taxable cancellation of debt for a rental property as “other income” at line 21 of Form 1040.
According to Revenue Ruling 92-92 and page 3 of IRS Publication 4681, cancellation of debt attributable to passive activity expenditures, such as purchase of the rental property, is passive activity income. For a rental property, the debt cancellation income should be included on line 3 of Schedule E as “rental income” for the property.
If some of the cancellation of debt income is attributable to funds used for a personal purpose, such as cash received from refinancing a property used to pay for a personal car or vacation, that portion does not qualify as passive activity income and still must be reported as “other income” on line 21 of Form 1040.
Reporting the cancellation of debt income as passive activity income will enable the taxpayer to not only use any unused passive activity losses for the foreclosed or short sold property as an offsetting deduction, but also unused passive activity losses from other properties or passive investments.
Be sure to watch for this when reporting cancellation of debt income for a rental property in 2009, and check whether an amended income tax return should be filed to correct errors on tax returns already filed.
Tags: cancel, debt, foreclosure, sale, short
3 Responses to “Tax help for rental property debt cancellation”
August 8th, 2010 at 4:01 pm
I have real estate (land only) that I am holding for investment purposes. I plan to short sale the property this year. The FMV has decreased since the date of purchase.
May I subtract my unused investment interest expense against the cancellation of debt income?
August 27th, 2010 at 8:17 am
I think you can.
According to Internal Revenue Code (IRC) Section 163(d)(1), noncorporate taxpayers may deduct investment interest expense up to the amount of net investment income for the year.
According to IRC Section 163(d)(4)(B)(i), investment income includes gross income from property held from investment.
The IRS recently ruled in a different context that cancellation of debt income can be investment income. (Letter Ruling 20106015.)
The gross income is reported at Line 4a on Form 4952.
IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.
January 17th, 2011 at 3:58 pm
I have an investment Condo in FL that I rent out January-March. I am told that if I use it more than 14 days a year I cannot consider it a rental property and it is considered a second home. I have a dilemna because I don’t fall into the rental property this year as I used it more than 14 days for personal use and and it is also not considered a “primary residence” because I work and reside in WI. Suggestions?
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