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IRS.gov Website
Publication 4681
taxmap/pubs/p4681-003.htm#en_us_publink1000192079

Reduction of Tax Attributes(p9)

rule
If you exclude canceled debt from income, you must reduce certain tax attributes (but not below zero) by the amount excluded. Use Part II of Form 982 to reduce your tax attributes. The order in which the tax attributes are reduced depends on the reason the canceled debt was excluded from income. If the total amount of canceled debt excluded from income (line 2 of Form 982) was more than your total tax attributes, the total reduction of tax attributes in Part II of Form 982 will be less than the amount on
line 2.
taxmap/pubs/p4681-003.htm#en_us_publink1000192080

Qualified Principal Residence Indebtedness(p9)

rule
If you exclude canceled qualified principal residence indebtedness from income and you continue to own the home after the cancellation, you must reduce the basis of the home (but not below zero) by the amount of the canceled qualified principal residence indebtedness excluded from income. Enter the amount of the basis reduction on line 10b of Form 982.
For more details on determining the basis of your main home, see Publication 523.
taxmap/pubs/p4681-003.htm#en_us_publink1000192081

Bankruptcy and Insolvency(p9)

rule
taxmap/pubs/p4681-003.htm#en_us_publink1000192082

No tax attributes other than basis of personal-use property.(p9)

rule
If the canceled debt you are excluding is not qualified principal residence indebtedness and you have no tax attributes other than the adjusted basis of personal-use property (see the list of seven tax attributes, later), you must reduce the basis of the personal-use property you held at the beginning of 2014 (in proportion to adjusted basis). Personal-use property is any property that is not used in your trade or business nor held for investment (such as your home, home furnishings, and car). Include on line 10a of Form 982 the smallest of:
For general information about the basis of property, see Publication 551.
taxmap/pubs/p4681-003.htm#en_us_publink1000192083

Example.(p9)

In 2011, Mya bought a car for personal use. The cost of the car was $12,000. Mya put down $2,000 and took out a loan of $10,000 to buy the car. The loan was a recourse loan, meaning that Mya was personally liable for the full amount of the debt.
On December 7, 2013, when the balance of the loan was $8,500, the lender repossessed and sold the car because Mya had stopped making payments on the loan. The FMV of the car was $7,000 at the time the lender repossessed and sold it. The lender applied the $7,000 it received on the sale of the car against Mya's loan and forgave the remaining loan balance of $1,500 ($8,500 outstanding balance immediately before the repossession minus the $7,000 FMV of the car).
Mya's only other assets at the time of the cancellation are the furniture in her apartment which has a basis of $5,000 and an FMV of $3,000, jewelry with a basis of $500 and an FMV of $1,000, and a $600 balance in her savings account. Thus, the FMV of Mya's total assets immediately before the cancellation was $11,600 ($7,000 car plus $3,000 furniture plus $1,000 jewelry plus $600 savings). Mya also had an outstanding student loan balance of $6,000 immediately before the cancellation, bringing her total liabilities at that time to $14,500 ($8,500 balance on car loan plus $6,000 student loan balance). Other than the car, which was repossessed, Mya held all of these assets at the beginning of 2014. The FMV and bases of the assets remained the same at the beginning of 2014.
Mya received a 2013 Form 1099-C showing $1,500 in box 2 (amount of debt that was canceled) and $7,000 in box 7 (FMV of the property). Mya can exclude all $1,500 of canceled debt from income because at the time of the cancellation, she was insolvent to the extent of $2,900 ($14,500 of total liabilities immediately before the cancellation minus $11,600 FMV of total assets at that time).
Mya checks box 1b on Form 982 and enters $1,500 on line 2. She enters $100 on line 10a (the smallest of: (a) the $5,500 bases of her personal-use property held at the beginning of 2014 ($5,000 furniture plus $500 jewelry), (b) the $1,500 nonbusiness debt she is excluding from income on line 2 of Form 982, or (c) the $100 excess of the total bases of the property and the amount of money Mya held immediately after the cancellation over her total liabilities at that time ($5,500 bases of property held immediately after the cancellation plus $600 savings minus $6,000 student loan).
Mya must reduce her bases in each item of property in proportion to her total adjusted bases in all her property. Thus, she reduces her basis in the furniture by $91 ($100 x $5,000/$5,500) and her basis in the jewelry by $9 ($100 x $500/$5,500).
taxmap/pubs/p4681-003.htm#en_us_publink1000192084

All other tax attributes.(p10)

rule
If the canceled debt is excluded by reason of the bankruptcy or insolvency exclusions, you must use the excluded debt to reduce the following tax attributes (but not below zero) in the order listed unless you elect to reduce the basis of depreciable property first, as explained later. Reduce your tax attributes after you figure your income tax liability for 2013.
  1. Net operating loss (NOL). First reduce any 2013 NOL and then reduce any NOL carryover to 2013 (after taking into account any amount used to reduce 2013 taxable income) in the order of the tax years from which the carryovers arose, starting with the earliest year. Reduce the NOL or carryover by one dollar for each dollar of excluded canceled debt.
  2. General business credit carryover. Reduce the credit carryover to or from 2013. Reduce the credit carryovers to 2013 in the order in which they are taken into account for 2013. For more information on the credit ordering rules for 2013, see the Instructions for Form 3800, General Business Credit. Reduce the carryover by 331/3 cents for each dollar of excluded canceled debt.
  3. Minimum tax credit. Reduce the minimum tax credit available at the beginning of 2014. Reduce the credit by 331/3 cents for each dollar of excluded canceled debt.
  4. Net capital loss and capital loss carryovers. First reduce any 2013 net capital loss and then any capital loss carryover to 2013 (after taking into account any amount used to reduce 2013 taxable income) in the order of the tax years from which the carryovers arose, starting with the earliest year. Reduce the net capital loss or carryover by one dollar for each dollar of excluded canceled debt.
  5. Basis. Reduce the bases of the property you hold at the beginning of 2014 in the following order (and, within each category, in proportion to adjusted basis).
    1. Real property held for investment or used in your trade or business (other than real property held for sale to customers in the ordinary course of business) if it secured the canceled debt.
    2. Personal property held for investment or used in your trade or business (other than inventory and accounts and notes receivable) if it secured the canceled debt.
    3. Other property held for investment or used in your trade or business (other than inventory, accounts receivable, notes receivable, and real property held for sale to customers in the ordinary course of business).
    4. Inventory, accounts receivable, notes receivable, and real property held primarily for sale to customers in the ordinary course of business.
    5. Personal-use property (property not used in your trade or business nor held for investment).
    Reduce the basis by one dollar for each dollar of excluded canceled debt. However, the reduction cannot be more than the excess of the total bases of the property and the amount of money you held immediately after the debt cancellation over your total liabilities immediately after the cancellation.
    For allocation rules that apply to basis reductions for multiple canceled debts, see Regulations section 1.1017-1(b)(2). Also see Election to reduce the basis of depreciable property before reducing other tax attributes, later.
  6. Passive activity loss and credit carryovers. Reduce the passive activity loss and credit carryovers from 2013. Reduce the loss carryover by one dollar for each dollar of excluded canceled debt. Reduce the credit carryover by 331/3 cents for each dollar of excluded canceled debt.
  7. Foreign tax credit. Reduce the credit carryover to or from 2013. Reduce the credit carryovers to 2013 in the order in which they are taken into account for 2013. Reduce the carryover by 331/3 cents for each dollar of excluded canceled debt.
taxmap/pubs/p4681-003.htm#en_us_publink1000192086

Election to reduce the basis of depreciable property before reducing other tax attributes.(p10)

rule
You can elect to reduce the bases of depreciable property you held at the beginning of 2014 before reducing other tax attributes. You can reduce the basis of this property by all or part of the canceled debt. Basis of property is reduced in the following order.
  1. Depreciable real property used in your trade or business or held for investment that secured the canceled debt.
  2. Depreciable personal property used in your trade or business or held for investment that secured the canceled debt.
  3. Other depreciable property used in your trade or business or held for investment.
  4. Real property held primarily for sale to customers if you elect to treat it as if it were depreciable property on Form 982.
Basis reduction is limited to the total adjusted bases of all your depreciable property. Depreciable property for this purpose means any property subject to depreciation or amortization, but only if a reduction of basis will reduce the depreciation or amortization otherwise allowable for the period immediately following the basis reduction. If the amount of canceled debt excluded from income is more than the total bases in depreciable property, you must use the excess to reduce the other tax attributes in the order described earlier under All other tax attributes. In figuring the limit on the basis reduction in (5), Basis, use the remaining adjusted bases of your properties after making this election. See Form 982 for information on how to make this election. The election can be revoked only with IRS consent.
taxmap/pubs/p4681-003.htm#en_us_publink1000192087

Recapture of basis reductions.(p10)

rule
If you reduce the basis of property under these provisions and later sell or otherwise dispose of the property at a gain, the part of the gain due to this basis reduction is taxable as ordinary income under the depreciation recapture provisions. Treat any property that is not section 1245 or section 1250 property as section 1245 property. For section 1250 property, determine the depreciation adjustments that would have resulted under the straight line method as if there were no basis reduction for debt cancellation. See Publication 544 or Publication 225 for more details on sections 1245 and 1250 property and the recapture of gain as ordinary income.
taxmap/pubs/p4681-003.htm#en_us_publink1000192088

Qualified Farm Indebtedness(p10)

rule
If you exclude canceled debt from income under both the insolvency exclusion and the exclusion for qualified farm indebtedness, you must first reduce your tax attributes by the amount excluded under the insolvency exclusion. Then reduce your remaining tax attributes (but not below zero) by the amount of canceled debt that qualifies for the farm debt exclusion.
In most cases, when reducing your tax attributes for canceled qualified farm indebtedness excluded from income, reduce them in the same order explained under Bankruptcy and Insolvency, earlier. However, do not follow the rules in item (5), Basis. Instead, reduce only the basis of qualified property. Qualified property is any property you use or hold for use in your trade or business or for the production of income. Reduce the basis of qualified property in the following order.
  1. Depreciable qualified property. You can elect on Form 982 to treat real property held primarily for sale to customers as if it were depreciable property.
  2. Land that is qualified property and is used or held for use in your farming business.
  3. Other qualified property.
taxmap/pubs/p4681-003.htm#en_us_publink1000192090

Qualified Real Property Business Indebtedness(p11)

rule
If you make an election to exclude canceled qualified real property business debt from income, you must reduce the basis of your depreciable real property (but not below zero) by the amount of canceled qualified real property business debt excluded from income. The basis reduction is made at the beginning of 2014. However, if you dispose of your depreciable real property before the beginning of 2014, you must reduce its basis (but not below zero) immediately before the disposition. Enter the amount of the basis reduction on line 4 of Form 982.
taxmap/pubs/p4681-003.htm#en_us_publink1000192091

Example 1.(p11)

In 2008 Curt bought a retail store for use in a business he operated as a sole proprietorship. Curt made a $20,000 down payment and financed the remaining $200,000 of the purchase price with a bank loan. The bank loan was a recourse loan and was secured by the property. He used the property in his business continuously since he bought it and had no other debt secured by that depreciable real property. In addition to the retail store, Curt owned depreciable equipment and furniture with an adjusted basis of $50,000. His tax attributes included the basis of depreciable property, a net operating loss, and a capital loss carryover to 2013.
Curt's business encountered financial difficulties in 2013. On September 26, 2013, the bank financing the retail store loan entered into a workout agreement with him under which it canceled $20,000 of the principal amount of the debt. Immediately before the bank entered into the workout agreement, he was insolvent to the extent of $12,000. At that time, the outstanding principal balance on the retail store loan was $185,000, the FMV of the store was $165,000, and the adjusted basis was $210,000 ($220,000 cost minus $10,000 accumulated depreciation). The bank sent him a 2013 Form 1099-C showing canceled debt of $20,000 in box 2.
Curt must apply the insolvency exclusion before applying the exclusion for canceled qualified real property business indebtedness. Under the insolvency exclusion rules, he can exclude $12,000 of the canceled debt from income. Curt elects to reduce his basis of depreciable property before reducing other tax attributes. Under that election, he must first reduce his basis in the depreciable real property used in his trade or business that secured the canceled debt. After the basis reduction, his adjusted basis in that property is $198,000 ($210,000 adjusted basis before entering into the workout agreement minus $12,000 of canceled debt excluded from income under the insolvency exclusion).
Curt may be able to exclude the remaining $8,000 of canceled debt from income under the exclusion for qualified real property business indebtedness, if he elects to apply it. The amount he can exclude is subject to both the following limits.
Since both limits are more than the $8,000 of remaining canceled debt ($20,000 minus $12,000), Curt can exclude $8,000 under the qualified real property business indebtedness exclusion.
Curt checks the boxes on lines 1b and 1d of Form 982. He completes Part II of Form 982 to reduce his basis in the depreciable real property by $20,000, the amount of the canceled debt excluded from income. He enters $8,000 on line 4 and $12,000 on line 5.
taxmap/pubs/p4681-003.htm#en_us_publink1000192092

Example 2.(p11)

Bob owns depreciable real property used in his retail business. His adjusted basis in the property is $145,000. The FMV of the property is $120,000. The property is subject to $134,000 of recourse debt which is secured by the property. Bob had no other debt secured by that depreciable real property. Bob also had a $15,000 NOL in 2013.
During 2013, Bob entered into a workout agreement with the lender under which the lender canceled $14,000 of the debt on the real property used in his business. Immediately before the cancellation, Bob was insolvent to the extent of $10,000. He excludes $10,000 of the canceled debt from income under the insolvency exclusion. As a result of that exclusion, he reduced his NOL by $10,000.
Bob may be able to exclude the remaining $4,000 of canceled debt from income under the qualified real property business indebtedness exclusion, if he elects to apply it. The amount he can exclude is subject to both of the following limits.
Since both limits ($14,000 and $145,000) are more than the remaining $4,000 of canceled debt, Bob can also exclude the remaining $4,000 of canceled debt.
Bob checks the boxes on lines 1b and 1d of Form 982 and enters $14,000 on line 2. Bob completes Part II of Form 982 to reduce his basis of depreciable real property and his 2013 NOL by entering $4,000 on line 4 and $10,000 on line 6. None of the canceled debt is included in his income.