As more and more commercial restaurant and retail ventures fail, property owners will seek debt relief from lenders who may be unwilling to repossess and would rather renegotiate the loan. When a business loan is modified to reduce or eliminate the amount owed it normally causes cancellation of debt income, which is taxable. Many times business owners are unaware of the consequences of debt cancellation until they receive a 1099-C.
If you are in this situation, you may be able to use Form 982 to exclude some or even all of the debt that has been forgiven when the debt is “qualified real property business indebtedness” (QRBI).
QRBI is money borrowed by any taxpayer in a trade or business (other than a C Corp) to acquire, construct, reconstruct or substantially improve the property and where the lender has a security interest in the property. Revenue Ruling – 2016-15 also applies this exclusion to property leased for residential purposes (unless it is or sale).
To apply for forgiveness, Form 982 is used and must be filed no later than 6 months after the due date of the return for the year where debt forgiveness occurred.
The amount of forgiveness is equal to the insolvent amount, or (debt before discharge less FMV of property before discharge), and is limited to the basis in all depreciable real property owned by the taxpayer. Basis in all retained real estate will be reduced by the debt forgiveness, and if later resold the gain will be ordinary up to the forgiveness amount.
If you, as a business owner has gone through this process and receives a 1099-C (would be after the first of the year for a debt cancellation that occurred in 2020), we can help you determine the level of insolvency. The calculated amount in that process determines the income and tax liability forgiven.
Note that a reduction in basis that occurs in this process results in higher capital gain in a later sale. (Nothing is free from the IRS).
Though we will see a lot of debt forgiveness as a result of Covid, the business debt relief process is not part of the Covid relief laws passed in 2020. Rather, this process has been around for many years and was a help to many homeowners facing foreclosure after the 2008 housing crisis. We saw a lot of 1099-C’s from homeowners for a number of years after the housing crisis and will likely see them from businesses for a number of years after Covid.
AFS – small business is our specialty