Q. As a power of attorney for my mother I sold her home in GA where she had lived for 18 years for $62M with a $5M downpayment and the balance to be paid in monthly installments to me to use to help with her support. She was 84 years old so no capital gain to report, in poor health and I had to move her cross country to live with me, then in assisted living and ultimately nursing home before her death. On the payments I received I reported the interest as income for 15 years. Then buyer stopped payments in 2011; foreclosure in mid 2012; sold property in Nov., 2012 at a tremendous loss. How do I report loss to IRS & CA? What forms? Can I take the entire loss ($30M) for 2012 or does it have to be spread out? Your detailed info will be much appreciated. Thank you.
A. You have a complicated situation, which cannot be fully analyzed with the information provided. It is not clear whether you inherited the installment note from the sale of your mother's home or she gifted it to you, so it is not clear what the tax basis in the note should be. There are special rules for determining what happens when the seller of a property reacquires a property securing an installment note (Internal Revenue Code Section 1038), but it is not clear that this provision would apply to someone who acquires the installment obligation by gift or inheritance, an aspect of this situation that would require research. This is key in that there are two very different results that would arise depending on whether Section 1038 applies or not.
Assuming that Section 1038 does not apply, and in the absence of any tax research regarding this specific situation, you may have had a taxable transaction at the reacquisition of the property by foreclosure equal to the difference between the tax basis of the unpaid principal of the installment obligation and the fair market value of the real property at that time. Since the installment note was probably a capital asset in your hands, the gain or loss would have been a capital gain or loss reportable in 2011. The gain or loss would have been reported on Schedule D of Form 1040. If the reacquisition had resulted in a loss, it would have been limited to your 2011 capital gain income, if any, plus up to $3,000 of other income. Any unused loss would be carried over to subsequent tax years until used up.
In 2012, you would have had a second transaction, the sale of the property. Its tax basis would have been the fair market value, as mentioned above. The gain or loss recognized in 2012 would have been difference between the sales price, net of selling expenses, and the tax basis. Most likely, the house would be a capital asset in your hands, so the resulting gain or loss would be a capital gain or loss reportable on Schedule D of Form 1040. If the sale of the house resulted in a loss, the loss would be subject to the limitations on capital losses described above.
There are no special forms for reporting capital gains and losses for California purposes, since the state follows the federal rules. Any differences between the amount of capital gain or loss that might arise due to, for example, tax basis differences, would be shown on California Schedule CA.
If Section 1038 applies to your situation, very different results would arise. No gain or loss is recognized on the reacquisition of the property and there is a special tax basis calculation for the reacquired property. Due to the complexity of the application of Section 1038, I am not going into an explanation of it here. You should consult with a tax advisor familiar with this provision.