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Cancellation of debt/bankruptcy .
Q. Taxpayer has basis in equipment of $6000. Debt owed on the equipment is $32,000. November of 2001 the bank takes the equipment (FMV of $50,000) for the loan, issues a 1099 cancellation of debt for the year 2001. In March of 2002 taxpayer declares bankruptcy. I know cancellation of debt is not income when a taxpayer is insolvent or bankrupt, but how do I report this on the return? Is the $6,000 basis a loss without recognizing the $32,000, thus resulting in loss of tax attributes?
A. Since there was no bankruptcy at time of loan cancellation, the fallback is to prove insolvency for all or part of the cancellation amount. (That is, if 1099-C says $32,000 and insolvency was $20,000, then 20,000 is not subject to income. You could report this as a sale on the 4797 and could then add a "1099-C Insolvency adjustment - $20,000" and deduct the 20,000 from the reported 32,000 amount before completing the 4797.
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