Tax Court Determines Year of Bases Reduction, Discharge of Debt

Tax Court Determines Year of Bases Reduction, Discharge of Debt

U.S. Tax Court

The Tax Court, declining to impose accuracy-related penalties, held that an individual was required to reduce his bases in depreciable real properties in 2012, the year in which he sold the properties, and found that he did not receive a discharge of indebtedness from a bank regarding properties he sold in 2013. Richard S. Hussey bought 27 investment properties in 2009 and assumed over $1.7 million in loans. He sold 16 of those properties in 2012. Fifteen of them were sold at a loss, and he received Forms 1099-C from the bank discharging his indebtedness. He sold another seven properties at a loss in 2013 but did not receive Forms 1099-C from the bank regarding those properties. Hussey filed his 2012 tax return, but later thought it might be incorrect and sought advice from a tax attorney with 30 years of experience who was recommended by his longtime financial adviser. The attorney prepared an amended return for 2012 and also prepared Hussey's 2013 and 2014 returns. On his 2012 return, Hussey reported that he had excludable income of $685,281 for a discharge of qualified real property business indebtedness (QRPBI) applied to reduce the basis of depreciable real property. On his 2013 return, he reported the sale of six investment properties and his primary residence at a loss, and for 2014 he reported a net operating loss carryover. The IRS issued a notice of deficiency for 2013 and 2014 disallowing the loss deductions and NOL carryover. Tax Court Judge John O. Colvin first considered whether Hussey was required to reduce his bases in 2012, the year in which the debt was discharged, or in 2013. Colvin explained that section 61(a)(10) and section 108(a)(1)(D) provide for an exclusion from income for discharged QRPBI. The court further explained that when the exclusion applies, the taxpayer must reduce his or her bases in the depreciable real properties. The parties agreed that Hussey was entitled to an exclusion for the QRPBI, but they disagreed regarding whether the bases in the depreciable real properties must be reduced in 2012, as the IRS claimed, or in 2013. In determining the year of the bases reductions, the court considered section 1017, which provides rules for when bases reductions are made following the discharge of QRPBI. Generally, section 1017(a) provides that the basis reduction occurs in the year following the discharge of indebtedness, but section 1017(b)(3)(F)(iii) provides an exception stating that the basis reduction for discharge of QRPBI occurs in the same year as the sale of “property taken into account under I.R.C. sec. 108(c)(2)(B).” Colvin concluded, based on section 1017(b)(3)(F)(iii), that Hussey was required to reduce his bases immediately before the sale of the investment properties in 2012. The Tax Court then considered whether Hussey had any discharge of indebtedness in 2013 and held that the bank did not discharge any of his debt in that year. The bank’s charge-off and recording of a loan loss reserve recovery did not amount to a discharge of indebtedness, the Tax Court held. Colvin also noted that the bank did not issue Forms 1099-C for 2013. Colvin ultimately held that Hussey is not liable for accuracy-related penalties, finding that he had reasonable cause and acted in good faith because he relied on an experienced tax attorney to prepare his returns after a referral by his longtime financial adviser.

The Tax Court, declining to impose accuracy-related penalties, held that an individual was required to reduce his bases in depreciable real properties in 2012, the year in which he sold the properties, and found that he did not receive a discharge of indebtedness from a bank regarding properties he sold in 2013.

The Tax Court, declining to impose accuracy-related penalties, held that an individual was required to reduce his bases in depreciable real properties in 2012, the year in which he sold the properties, and found that he did not receive a discharge of indebtedness from a bank regarding properties he sold in 2013. Richard S. Hussey bought 27 investment properties in 2009 and assumed over $1.7 million in loans. He sold 16 of those properties in 2012. Fifteen of them were sold at a loss, and he received Forms 1099-C from the bank discharging his indebtedness. He sold another seven properties at a loss in 2013 but did not receive Forms 1099-C from the bank regarding those properties. Hussey filed his 2012 tax return, but later thought it might be incorrect and sought advice from a tax attorney with 30 years of experience who was recommended by his longtime financial adviser. The attorney prepared an amended return for 2012 and also prepared Hussey's 2013 and 2014 returns. On his 2012 return, Hussey reported that he had excludable income of $685,281 for a discharge of qualified real property business indebtedness (QRPBI) applied to reduce the basis of depreciable real property. On his 2013 return, he reported the sale of six investment properties and his primary residence at a loss, and for 2014 he reported a net operating loss carryover. The IRS issued a notice of deficiency for 2013 and 2014 disallowing the loss deductions and NOL carryover. Tax Court Judge John O. Colvin first considered whether Hussey was required to reduce his bases in 2012, the year in which the debt was discharged, or in 2013. Colvin explained that section 61(a)(10) and section 108(a)(1)(D) provide for an exclusion from income for discharged QRPBI. The court further explained that when the exclusion applies, the taxpayer must reduce his or her bases in the depreciable real properties. The parties agreed that Hussey was entitled to an exclusion for the QRPBI, but they disagreed regarding whether the bases in the depreciable real properties must be reduced in 2012, as the IRS claimed, or in 2013. In determining the year of the bases reductions, the court considered section 1017, which provides rules for when bases reductions are made following the discharge of QRPBI. Generally, section 1017(a) provides that the basis reduction occurs in the year following the discharge of indebtedness, but section 1017(b)(3)(F)(iii) provides an exception stating that the basis reduction for discharge of QRPBI occurs in the same year as the sale of “property taken into account under I.R.C. sec. 108(c)(2)(B).” Colvin concluded, based on section 1017(b)(3)(F)(iii), that Hussey was required to reduce his bases immediately before the sale of the investment properties in 2012. The Tax Court then considered whether Hussey had any discharge of indebtedness in 2013 and held that the bank did not discharge any of his debt in that year. The bank’s charge-off and recording of a loan loss reserve recovery did not amount to a discharge of indebtedness, the Tax Court held. Colvin also noted that the bank did not issue Forms 1099-C for 2013. Colvin ultimately held that Hussey is not liable for accuracy-related penalties, finding that he had reasonable cause and acted in good faith because he relied on an experienced tax attorney to prepare his returns after a referral by his longtime financial adviser.

Sec. 108 Income from discharge of indebtedness

Sec. 1017 Discharge of indebtedness

Sec. 6662 Imposition of accuracy-related penalty on underpayments

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Tax Court Determines Year of Bases Reduction, Discharge of Debt