Can you clarify basis adjustmenting as relating to short sales and foreclosures?

August 12, 2011

From:  Dan
Date:  12 Jan 2009
Subject:  Real Estate Tax Handbook Mortgage Foregiveness Debt Relief Act of 2007

When you wrote about short sales and mortgage forgiveness and the tax impact when the taxpayer continues to live in the residence, you stated you only had authority in the IRS publication (which is no authority). According to the statute, basis reduction only applies to the personal residence of the taxpayer and he or she no longer has one in a foreclosure or short sale.

Would you please clarify this matter?

Answer

Date:  14 Jan 2009

Hello Dan,

In my article, I pointed out that, according to the IRS publication, there is no basis adjustment when the property is sold coincidentally with the debt cancellation, such as in a short sale or a foreclosure.

The authority for this position is Internal Revenue Code Section 1017.

That section applies if an amount is excluded from gross income under the cancellation of indebtedness section – Section 108(a). The exclusion for residential mortgage interest is under Section 108(a)(1)(E).

The basis reduction applies to the basis of "any property held by the taxpayer at the beginning of the taxable year following the taxable year in which the discharge occurs". (Section 1017(a).)

Since the taxpayer will no longer own the residence at the beginning of the next taxable year after the discharge because it was sold or foreclosed at the time of the discharge, the basis adjustment doesn’t apply.

Good luck!
Mike Gray

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