Foreclosure or Repossession

If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. This is true even if you voluntarily return the property to the lender. You may also realize ordinary income from cancellation of debt if the loan balance is more than the fair market value of the property.

Buyer's (borrower's) gain or loss.   You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. See Determining Gain or Loss, earlier.

(Keep for your records)

Table 10-2. Worksheet for Foreclosures and Repossessions

Part 1. Figure your income from cancellation of debt. (Note: If you are not personally liable for the debt, you do not have income from cancellation of debt. Skip Part 1 and go to Part 2.)
1.	Enter amount of debt canceled by the transfer of property
2.	Enter the fair market value of the transferred property
3.	Income from cancellation of debt.* Subtract line 2 from line 1. If less than zero, enter zero
Part 2. Figure your gain or loss from foreclosure or repossession.
4.	Enter the smaller of line 1 or line 2. Also include any proceeds you received from the foreclosure sale. (If you are not personally liable for the debt, enter the amount of debt cancelled by the transfer of property.)
5.	Enter the adjusted basis of the transferred property
6.	Gain or loss from foreclosure or repossession. Subtract line 5 from line 4

*The income may not be taxable. See Cancellation of debt.

You can use Table 10-2 to figure your gain or loss from a foreclosure or repossession.

Amount realized on a nonrecourse debt.   If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full amount of the debt canceled by the transfer. The total canceled debt is included in the amount realized even if the fair market value of the property is less than the canceled debt.

Example 1.   Ann paid $200,000 for land used in her farming business. She paid $15,000 down and borrowed the remaining $185,000 from a bank. Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. The bank foreclosed on the loan 2 years after Ann stopped making payments. When the bank foreclosed, the balance due on the loan was $180,000 and the fair market value of the land was $170,000. The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. She figures her gain or loss in Part I, Form 4797, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). She has a $20,000 deductible loss.

Example 2.   Assume the same facts as in Example 1 except the fair market value of the land was $210,000. The result is the same. The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. Because her adjusted basis is $200,000, she has a deductible loss of $20,000, which she reports in Part I, Form 4797.

Amount realized on a recourse debt.   If you are personally liable for repaying the debt (recourse debt), the amount realized on the foreclosure or repossession does not include the canceled debt that is income from cancellation of debt. However, if the fair market value of the transferred property is less than the canceled debt, the amount realized includes the canceled debt up to the fair market value of the property. You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. See Cancellation of debt, later.

Example 3.   Assume the same facts as in Example 1 earlier except Ann is personally liable for the loan (recourse debt). In this case, the amount she realizes is $170,000. This is the canceled debt ($180,000) up to the fair market value of the land ($170,000). Ann figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($200,000). She has a $30,000 deductible loss, which she figures in Part I, Form 4797. She is also treated as receiving ordinary income from cancellation of debt. That income is $10,000 ($180,000 - $170,000). This is the part of the canceled debt not included in the amount realized. She reports this income on line 10 of Schedule F.

Seller's (lender's) gain or loss on repossession.   If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. For more information, see Repossession in Publication 537.

Cancellation of debt.   If property that is repossessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the fair market value of the property. This income is separate from any gain or loss realized from the foreclosure or repossession. Report the income from cancellation of a business debt on Schedule F, line 10. Report the income from cancellation of a nonbusiness debt as miscellaneous income on line 21, Form 1040.

You can use Table 10-2 to figure your income from cancellation of debt.

However, income from cancellation of debt is not taxed if any of the following apply.

• The cancellation is intended as a gift.
• The debt is qualified farm debt (see chapter 4).
• The debt is qualified real property business debt (see chapter 5 of Publication 334).
• You are insolvent or bankrupt (see chapter 4).

Abandonment

The abandonment of property is a disposition of property. You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership, but without passing it on to anyone else.

Business or investment property.   Loss from abandonment of business or investment property is deductible as an ordinary loss, even if the property is a capital asset. The loss is the property's adjusted basis when abandoned. This rule also applies to leasehold improvements the lessor made for the lessee that were abandoned. However, if the property is later foreclosed on or repossessed, gain or loss is figured as discussed earlier under Foreclosure or Repossession.

The abandonment loss is deducted in the tax year in which the loss is sustained. Report the loss on Form 4797, Part II, line 10.

Example.   Abena lost her contract with the local poultry processor and abandoned poultry facilities that she built for $100,000. At the time she abandoned the facilities, her mortgage balance was $85,000. She has a deductible loss of $66,554 (her adjusted basis). If the bank later forecloses on the loan or repossesses the facilities, she will have to figure her gain or loss as discussed earlier under Foreclosure or Repossession.

Personal-use property.   You cannot deduct any loss from abandonment of your home or other property held for personal use.

Canceled debt.   If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you will realize ordinary income equal to the canceled debt. This income is separate from any loss realized from abandonment of the property. Report income from cancellation of a debt related to a business or rental activity as business or rental income. Report income from cancellation of a nonbusiness debt as miscellaneous income on line 21, Form 1040.

However, income from cancellation of debt is not taxed in certain circumstances. See Cancellation of debt, earlier.

Forms 1099-A and 1099-C.   A lender who acquires an interest in your property in a foreclosure, repossession, or abandonment should send you Form 1099-A showing the information you need to figure your loss from the foreclosure, repossession, or abandonment. However, if your debt is canceled and the lender must file Form 1099-C, the lender may include the information about the foreclosure, repossession, or abandonment on that form instead of Form 1099-A. The lender must file Form 1099-C and send you a copy if the canceled debt is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. For foreclosures, repossessions, or abandonments of property and debt cancellations occurring in 2002, these forms should be sent to you by January 31, 2003.

Dispositions of Property Used in Farming

Introduction

When you dispose of property used in your farm business, your taxable gain or loss is usually a section 1231 gain or loss. Its treatment as ordinary income, which is taxed at the same rates as wages and interest income, or capital gain, which is generally taxed at lower rates, is determined under the rules for section 1231 transactions.

When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remaining after applying the depreciation recapture rules is a section 1231 gain, which may be taxed as a capital gain.

Gains and losses from property used in farming are reported on Form 4797. Table 11-1 contains examples of items reported on Form 4797 and refers to the part of that form on which they first should be reported. Chapter 20, Sample Return, contains a sample filled-in Form 4797.

Topics

This chapter discusses:

• Section 1231 gains and losses
• Depreciation recapture
• Other gains

Useful Items You may want to see:

Publication

• 544   Sales and Other Dispositions
  of Assets

Form (and Instructions)

• 4797   Sales of Business Property

See chapter 21 for information about getting publications and forms.

Section 1231 Gains and Losses

Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions - generally, dispositions of property used in business. Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions in the tax year.

Table 11-1.Where To Report Items on Form 4797

Type of property		Held 1 year or less	Held longer than 1 year
1	Depreciable trade or business property:
	a  Sold or exchanged at a gain	Part II	Part III (1245, 1250)
	b  Sold or exchanged at a loss	Part II	Part I
2	Depreciable residential rental property:
	a  Sold or exchanged at a gain	Part II	Part III (1250)
	b  Sold or exchanged at a loss	Part II	Part I
3	Farm land held less than 10 years for which soil, water, or land clearing expenses were deducted:
	a  Sold at a gain	Part II	Part III (1252)
	b  Sold at a loss	Part II	Part I
4	Disposition of cost-sharing payment property described in section 126	Part II	Part III (1255)
5	Cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes:	Held less than 24 mos.	Held 24 mos. or longer
	a Sold at a gain	Part II	Part III (1245)
	b  Sold at a loss	Part II	Part I
	c  Raised cattle and horses sold at a gain	Part II	Part I
6	Livestock other than cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes:	Held less than 12 mos.	Held 12 mos. or longer
	a  Sold at a gain	Part II	Part III (1245)
	b  Sold at a loss	Part II	Part I
	c  Raised livestock sold at a gain	Part II	Part I

If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). Do not take that gain into account as section 1231 gain.

Section 1231 transactions.   Gain or loss on the following transactions is subject to section 1231 treatment.

• Sale or exchange of cattle and horses. The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 2 years or longer.
• Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 1 year or longer. Other livestock includes hogs, mules, sheep, and goats, but does not include poultry.
• Sale or exchange of depreciable personal property. This property must be used in your business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable section 197 intangibles.
• Sale or exchange of real estate. This property must be used in your business and held longer than 1 year. Examples are your farm or ranch (including barns and sheds).
• Sale or exchange of unharvested crops. The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a lease on the land, even if sold to the same person in a single transaction, are not included.
• Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed earlier and held longer than 1 year (or for the required period for certain livestock).
• Cutting or disposal of timber. You must treat the cutting or disposal of timber as a sale, as described in chapter 10 under Timber.
• Condemnation. The condemned property (defined in chapter 13) must have been held longer than 1 year. It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.
• Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). You must have held the property longer than 1 year. However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. Section 1231 does not apply to personal casualty gains and losses. See chapter 13 for information on how to treat these gains and losses.

Property for sale to customers.   A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers.

Treatment as ordinary or capital.   To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year.

• If you have a net section 1231 loss, it is an ordinary loss.
• If you have a net section 1231 gain, it is ordinary income up to your nonrecaptured section 1231 losses from previous years, explained next. The rest, if any, is long-term capital gain.

Nonrecaptured section 1231 losses.   Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain by treating the gain as ordinary income. These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period.

Example.   In 2002 Ben has a $2,000 net section 1231 gain. To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. From 1997 through 2001 he had the following section 1231 gains and losses.

Year			Amount
1997
1998
1999			($2,500)
2000			-0-
2001			$1,800

Using this information, Ben figures how to report his net section 1231 gain for 2002 as shown below.

1)	Net section 1231 gain (2002)		$2,000
2)	Net section 1231 loss (1999)	($2,500)
3)	Net section 1231 gain (2001)	1,800
4)	Remaining net section 1231 loss	($700)
5)	Gain treated as ordinary income		$700
6)	Gain treated as long-term capital gain		$1,300

His net section 1231 loss from 1999 is completely recaptured in 2002.

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