What this line means
Check this box if the canceled debt was qualified real property business indebtedness. This means debt that was secured by real property used in a trade or business and was incurred or assumed in connection with that real property. The exclusion is limited to the excess of the outstanding principal (immediately before the discharge) over the fair market value of the property securing the debt, reduced by any other qualified real property business debt secured by that property.
Does this apply to you?
- You had business real estate debt canceled or restructured, such as a commercial mortgage or loan on a rental property
- The debt was secured by real property used in your trade or business (not your personal residence)
- You are not a C corporation (this exclusion applies to individuals, partnerships, S corporations, and other non-C-corp taxpayers)
- You want to exclude the canceled debt without being in bankruptcy or proving insolvency
Easy to overlook
The exclusion cannot exceed the adjusted basis of all your depreciable real property Even if the formula (outstanding debt minus FMV) produces a large number, the exclusion is capped at the aggregate adjusted basis of your depreciable real property held immediately before the discharge. Filers with fully depreciated buildings may have little or no basis left to absorb the exclusion, leaving a portion of the canceled debt taxable. 1 IRS Publication 4681 — Canceled Debts, Foreclosures, Repossessions, and Abandonments
Acquisition debt only — refinanced cash-out amounts do not qualify Only debt incurred to acquire, construct, or substantially improve the real property qualifies. If you refinanced and pulled out cash for other purposes, the cash-out portion is not qualified real property business indebtedness. You must trace the loan proceeds to determine how much of the debt qualifies. 2 IRS Form 982 Instructions — Line 1d
Watch out for this
Applying this exclusion to rental property that is not a trade or business. The IRS distinguishes between rental activities that rise to the level of a trade or business and passive rental activities that do not. If your rental does not qualify as a trade or business, the debt may not meet the “used in a trade or business” requirement. Review your classification before checking this box.
Footnotes
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IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, Chapter 2. https://www.irs.gov/pub/irs-pdf/p4681.pdf ↩
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IRS Form 982 Instructions, Line 1d. https://www.irs.gov/instructions/i982 ↩