Reduction in Attributes

We have already mentioned our next topic several times — Reduction of Tax Attributes. While not in and of itself an Exclusion, it is an action that must be taken when certain Exclusions are used. This basically means that you must reduce the amount of “tax credit” (or positive attributes) you have in your held assets by the amount of the exclusion.

The effective date of the reduction is the first day of the tax year immediately following the year the exclusion is used. The reduction in attributes is made after computing the tax for the year in which the exclusion is used. Reductions in carryovers, carry-backs, and credits are made in the order they arose.

For Example: If I used the QPRI Exclusion in 2013 and I continue to own the home, I must reduce my basis in the residence by the amount of the exclusion, but not below zero, effective 1/1/2014.

Like most things to do with Cancellation of Debt there is a specific order by which the Tax Attributes must be reduced. That order is as follows:

1. Net Operating Loss (NOL) for the year of the cancellation and any NOL carryovers to the year of the cancellation. This is a dollar for dollar reduction by the amount of the exclusion.

2. General business credit carryovers to or from the year of cancellation. Since this is a credit, it is reduced 33.33 cents per dollar of the exclusion.

3. Minimum tax credit available at the beginning of the year following the year of the cancellation. Since this is a credit, it is reduced 33.33 cents per dollar of the exclusion.

4. Any capital loss carryovers from the year of the cancellation. This is a dollar for dollar reduction by the amount of the exclusion.

5. The basis of all property other than money. This is a dollar for dollar reduction by the amount of the exclusion and has its own ordering:

a)      Real property used in business or investment that actually secured the canceled debt.

b)      Personal property used in business or an investment that actually secured the canceled debt.

c)      Other property used in business or investment.

d)     Inventory, accounts receivable, and real property held for sale to customers.

e)      Personal use property not used for business or investment.

f)       Passive activity loss or credit carryovers from the year of the cancellation.

g)   Foreign tax credit carryover to or from the year of the cancellation.

There is an exception to the ordering rule here, a debtor may elect to reduce their basis in all depreciable property before reducing any other tax attributes. Remember, this is property that he still owns on the first day of the tax year following the year of cancellation. Therefore, if the property was seized as part of the cancellation of debt the debtor has no property to reduce the basis of on the first day of the following year.

If a taxpayer elects to use this method, they must treat the reduction in basis as depreciation claimed when determining recapture provisions upon the disposition of the property.

For Example:  James had an office building that he rented to a store owner. In August 2013, James restructured his loan on the building to avoid foreclosure. He received a 1099C in the amount of $25,000 and excluded this under the Qualified Real Property Business Debt Exclusion. James’ remaining basis in the building on 1/1/14 was $100,000. He elected to reduce the attributes in his depreciable properties and therefore reduced the basis in the building by $25,000. In 2014, when James disposes of the building, he will have to take all the regularly accumulated depreciation plus the additional $25,000 into his recapture calculations.

The reduction of tax attributes and the exclusion of CODI are reported on Form 982, line 5. Even though James will not have any taxable CODI or gain, he will still attach the form 982 to the 2013 tax return when it is filed. We will complete this form in the comprehensive example at the end of the course.

Next:  Part 13, Documentation