Step #4 – Complete IRS Form 982 and Reduce Tax Attributes
Step #4 in a debt relief plan is to complete IRS Form 982 and reduce tax attributes if required for the particular exclusion method. This is the final step.
Only One Form 982 – Potential for Confusion
It is possible that a taxpayer can have multiple discharges of debt during the year or use multiple exclusion methods for a single discharge of debt. However, only one Form 982 can be submitted. The instructions for the 982 say to check the appropriate box(es) indicating the type of exclusion or exclusions used.This can create some confusion down the road if the exclusion of income or reduction of attributes is subsequently challenged. The author recommends that practitioners complete a separate Form 982 (use it as a worksheet) for each separate event and each different exclusion method used for each event. Number them in sequence and combine the results for the single Form 982 to be filed. This will provide an audit trail for the future.
Supplemental Attachment to Identify Property Subject to Basis Reduction – The instructions for Form 982 state that when basis is required to be reduced under Code Section 1017 a list of the property and the amount of basis reduction for each must be attached to the filed return. The following is a suggested format for such a statement.
CAUTION - Basis Reduction Recaptures as Ordinary Income!
To ensure that ordinary income treatment eventually will be given to the full amount of basis reduction made to depreciable or non-depreciable assets when debt discharge amounts are excluded from a debtor's income, any gain upon a debtor's subsequent disposition of reduced-basis property is generally subject to recapture as ordinary income. For recapture purposes, any reduction of the basis of property due to debt discharge amounts is treated as a deduction allowed for depreciation. (IRC Sec. 1017(d)(1)(B)) This rule even applies to the sale of a home where the Sec 121 exclusion cannot be used to offset gain that is depreciation recapture. Exception – With respect to Sec 1250 property, the amount of basis reduction that is recaptured as ordinary income is reduced whenever the taxpayer's depreciation deductions are reduced because of the basis reduction (H Rept No. 103-11 (PL 103-66) p. 625.)
Because each exclusion method has a different sequence of attribute reductions and special rules pertaining to the exclusion method, the following charts were developed to assist with this final task.
Where To Report COD Income
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To the extent it is excludable, the COD income would be reported on line 2 of the Form 982.
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To the extent it is taxable, report as follows (Pub 4681):
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Nonbusiness debt – pre-2018 – line 21 on Form 1040 or Form 1040NR; 2018 – line 21 is on Schedule 1; 2019 or 2020 – line 8 on Schedule 1; 2021 – line 8c on Schedule 1
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Non-farm sole proprietorship – Line 6 Schedule C,
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Non-farm rental of real property – Schedule E, line 3
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Farm rental activity – Form 4835, line 6
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Farm debt and the taxpayer is the farmer – Schedule F, line 8
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COD Income as Investment Income
If the COD income is from property held for investment, then it is treated as investment income and increases the limitation for deducting investment interest expense and allows a larger deduction of investment interest. (IRS Letter Ruling 200952018, 9/17/2009). As investment income it could also be subject to the 3.8% net investment income tax should the taxpayer’s AGI exceed the taxation threshold.