Compliance Project Assignment: COD Income Problem
Joseph Poorman graduated from San Diego State University in 1997 and began working as a professional. As he began his career, he immediately started investing a part of his salary, using a variety of investment vehicles. Over about a decade, he had put together a healthy portfolio of investments, and was very satisfied with his life and finances. However, starting in 2008, both the real estate and the stock market and the overall economy took a drastic downturn, leaving many investors like Joseph devastated. In 2010, Joseph's asset profile was as follows:
|
Rental Property A
|
93,745
|
178,500
|
150,914
|
|
Rental Property B
|
97,000
|
122,150
|
200,371
|
|
Rental Property C
|
37,275
|
107,430
|
107,428
|
|
Rental Property D
|
150,000
|
96,251
|
140,679
|
|
Retirement Account ($401(k))
|
450,000
|
|
|
|
Personal Residence
|
350,000
|
405,000
|
352,154
|
|
Investment in Land
|
3,500
|
85,000
|
3,814
|
|
Universal Life Insurance Policy
|
1,000
|
4,500
|
|
|
Vangaugh Mutual Fund
|
7,300
|
11,408
|
|
|
Bells Farvo Mutual Fund
|
2,000
|
3,085
|
|
|
Stock Portfolio
|
5,488
|
12,540
|
|
|
Other Personal Property
|
6,350
|
6,000
|
|
|
Other Personal Property
|
2,000
|
10,000
|
|
|
Interest in Real Estate partnership
|
10,000
|
26,968
|
|
|
Cash on hand
|
5,792
|
5,792
|
|
|
Automobile
|
11,000
|
19,130
|
|
|
Student Loans
|
|
|
9,713
|
|
Totals
|
1,232,450
|
1,093,754
|
965,073
|
Joseph realized that his situation was no longer sustainable. The tenants in his rental were all experiencing financial difficulty and could not pay their rent, leaving him with a heavy load of negative cash flow on his rentals. He was able to short-sell Rental Property A, with net proceeds of $93,745 going to the lender in exchange for relief from the remaining loan balance on that property. After the short-sale, Joseph consulted with a bankruptcy attorney and concluded that the best way to get out of the situation he was in with the least amount of damage to his financial profile and credit was declaring bankruptcy.
Joseph, generally a financially sensible man, did not have much in unsecured debts. He paid off all credit card balances and closed his unsecured lines of credit before the bankruptcy proceedings. The only unsecured debt he had going into bankruptcy was his federal student loan with a balance of $9,713, which, by operation of federal law, is not dischargeable in bankruptcy.
Joseph's objective in filing for bankruptcy was to get out from the unbearable load the "upside down" rental properties, and to avoid the tax consequences of the cancellation of the debt encumbering those properties. He wished to keep all of his other assets and investments intact through the proceedings, if possible. In addition, Rental Property D was a local investment with some hope that its value would recover soon. Joseph wished to keep this property through bankruptcy, if he could get a good settlement on paying off the remaining balance of over $140,000 encumbering it.
Accordingly, after filing the bankruptcy petition, Joseph approached the lender on property D and was able to negotiate the loan down. In exchange for a cash payment of $25,000, the bank would release the title to this property and forgive the balance of the loan. Joseph made the 25,000 by borrowing the portion he did not have in cash from his sister, to be repaid after the dust settled from the bankruptcy.
The Bankruptcy Court approved the plan to discharge the debt on Rental Properties B and C, granting title on those properties to the lender. The Court also discharged any unpaid balance of the loan on rental property D, while Joseph retained his title to that property free and clear. Joseph was able to keep all of his other property free from any creditor's claims, but subject to any liens created by the debt encumbering those properties that he retained. The summary of the debt balances that Joseph was able to free himself from is as follows:
|
Property
|
Rental A
|
Rental B*
|
Rental C*
|
Rental D
|
Total
|
|
Proceed to Lender
|
93,745
|
97,000
|
37,275
|
25,000
|
253,020
|
|
Remaining Loan Balance
|
150,914
|
200,371
|
107,428
|
140,679
|
599,392
|
|
Cancellation of Debt
|
57,169
|
103,371
|
70,153
|
115,679
|
346,372
|
|
|
Outside BK
|
Through BK
|
Through BK
|
Through BK
|
|
|
Manner of discharge
|
Proceedings
|
Proceedings
|
Proceedings
|
Proceedings
|
|
* For properties B and C proceed to lender consists of the fair market value of the property relinquished.
Immediately after the results of the bankruptcy proceedings in 2010, Joseph sold his entire stock portfolio for $5,488. He had no other capital gains or losses for 2010.
Required:
A. Compute the amount of income that Joseph must report on his Form 1040 for 2010as a result of the above discharge of indebtedness.
B. Assume that after computing any taxable portion of the discharge of indebtedness income in part A above, taking into account the losses on the disposition of the lost properties, and Joseph's salary and other income, you have computed a net operating loss for 2010 of $69,296. Please prepare a Form 982 to attach to Joseph's 2010 return, disclosing the amount of reduction of Joseph's tax attributes. In addition, prepare a supporting schedule to be attached to this form, which computes and reconciles the total amount of debt discharged, total amount required to reduce tax attributes, attributes reduced, and all attributes (including basis of remaining assets going into future years.