IRS Form 982 - Reducing Tax Attributes of Depreciable Property for Cancelled Debt - John R. Dundon II, Enrolled Agent
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IRS Form 982 – Reducing Tax Attributes of Depreciable Property for Cancelled Debt

The Perturbing New Treatment of Patents Under the Tax Cut & Jobs Act (TCJA)

IRS Form 982 – Reducing Tax Attributes of Depreciable Property for Cancelled Debt

If debt is canceled in a bankruptcy case or during insolvency you must use the excluded amount of debt to reduce certain “tax attributes” including the basis of certain assets as well as losses and credits. Essentially by reducing tax attributes, the tax on the canceled debt is partially postponed instead of being entirely forgiven preventing excessive tax benefits from the debt cancellation.

Generally, use the amount of canceled debt to reduce the tax attributes in the order listed below. You may however first choose to use all or a part of the amount of canceled debt to first reduce the basis of property that you’ve previously depreciated before reducing the other tax attributes.

1. Reduce any Net Operating Loss (NOL) for the tax year in which the debt cancellation takes place, and any NOL carryover to that tax year.

2. Reduce any carryovers, to or from the tax year of the debt cancellation, of amounts used to determine the general business credit.

3. Reduce any minimum tax credit that is available as of the beginning of the tax year following the tax year of the debt cancellation.

4. Reduce any net capital loss for the tax year of the debt cancellation, and any capital loss carryover to that year.

5. Reduce the basis of both depreciated and non-depreciated property.

6. Reduce any passive activity loss or credit carryover from the tax year of the debt cancellation.

7. Reduce any carryover, to or from the tax year of the debt cancellation, of an amount used to determine the foreign tax credit or the Puerto Rico and possession tax credit.

Except for the credit carryovers, reduce the tax attributes listed earlier dollar for each dollar of canceled debt that is excluded from income. Reduce the credit carryovers by 33 cents for each dollar of canceled debt that is excluded from income.

Make the required reductions in tax attributes after figuring the tax for the tax year of the debt cancellation. In reducing NOLs and capital losses, first reduce the loss for the tax year of the debt cancellation, and then any loss carryovers to that year in the order of the tax years from which the carryovers arose, starting with the earliest year. Make the reductions of credit carryovers in the order in which the carryovers are taken into account for the tax year of the debt cancellation.

Reductions in basis due to debt cancellation are made at the beginning of the tax year following the cancellation according to IRC 1.1017-1.

The reduction in basis for canceled debt in bankruptcy or in insolvency cannot be more than the total basis of property held immediately after the debt cancellation, minus the total liabilities immediately after the cancellation. This limit does not apply if an election is made to reduce basis before reducing other attributes.

Make the election to reduce the basis of depreciated property before reducing other tax attributes, as well as the election to treat real property inventory as depreciated property, on IRS Form 982.

If any basis in property is reduced under these provisions and is later sold or otherwise disposed of at a gain, the part of the gain corresponding to the basis reduction is taxable as ordinary income. Figure the ordinary income part by treating the amount of the basis reduction as a depreciation deduction and by treating any such basis-reduced property that is not already either IRC section 1245 or IRC section 1250 property as IRC section 1245 property. In the case of IRC section 1250 property, make the determination of what would have been straight line depreciation as though there had been no basis reduction for debt cancellation. IRC sections 1245 and 1250 and the recapture of gain as ordinary income.

If a partnership’s debt is canceled because of bankruptcy or insolvency, the rules for the exclusion of the canceled amount from gross income and for tax attribute reduction are applied at the individual partner level. Thus, each partner’s share of debt cancellation income must be reported on the partner’s return unless the partner meets the bankruptcy or insolvency exclusions explained earlier.

For purposes of reducing the basis of depreciable property in attribute reduction, a partner treats his or her partnership interest as depreciable property to the extent of the partner’s proportionate interest in the partnership’s depreciable property. This applies only if the partnership makes a corresponding reduction in the partnership’s basis in its depreciable property with respect to the partner.

The allocation of an amount of debt cancellation income to a partner results in that partner’s basis in the partnership being increased by that amount. At the same time, the reduction in the partner’s share of partnership liabilities caused by the debt cancellation results in a deemed distribution, in turn resulting in a reduction of the partner’s basis in the partnership. These basis adjustments are separate from any basis reduction under the attribute-reduction rules described earlier.

Corporations in a bankruptcy proceeding or insolvency generally follow the same rules for debt cancellation and reduction of tax attributes as an individual or individual bankruptcy estate would follow.

If a corporation transfers its stock (or if a partnership transfers an interest in the partnership) in satisfaction of indebtedness and the FMV of the stock or interest is less than the indebtedness owed, the corporation or partnership has income to the extent of the difference from the cancellation of indebtedness. The corporation or partnership can exclude all or a portion of the income created by the stock or interest debt transfer if it is in a bankruptcy proceeding or, if not in a bankruptcy proceeding, it can exclude the income to the extent it is insolvent. However, the corporation or partnership must reduce its tax attributes to the extent it has any by the amount of the excluded income.

Earnings and profits of a corporation do not include income from the discharge of indebtedness to the extent of the amount applied to reduce the basis of the corporation’s property as explained earlier. Otherwise, discharge of indebtedness income, including amounts excluded from gross income, increases the earnings and profits of the corporation (or reduces a deficit in earnings and profits).

If there is a deficit in the corporation’s earnings and profits and the interest of any shareholder of the corporation is terminated or extinguished in a title 11 or similar case, the deficit must be reduced by an amount equal to the paid-in capital allocable to the shareholder’s terminated or extinguished interest.

For S corporations, the rules for excluding income from debt cancellation because of bankruptcy or insolvency apply at the corporate level.

A loss or deduction that is disallowed for the tax year of the debt cancellation because it exceeds the shareholders’ basis in the corporation’s stock and debt is treated as an NOL for that tax year in making the required reduction of tax attributes for the amount of the canceled debt.