Would I be charged capital gains tax for selling a property discharged in bankruptcy?

by Michael A. Gillen, CPA | Jun 08, 2018

I have a duplex that was discharged in a 2012 bankruptcy. Now, the home is in foreclosure, which is fine with me. My tenant wants to buy it. If I sold it, would I be taxed capital gains on the sale price or on the depreciated value that was submitted on income tax filings? Or, since it was discharged in bankruptcy, would I not be taxed on any gains?

When it comes to real estate, a taxable event occurs upon transfer. As such, the taxable event would not occur until the lender forecloses on the property or the property is sold before foreclosure.

Assuming the mortgage on the investment property was previously discharged in a chapter 7 bankruptcy, there are two potential tax issues: forgiven debt income and capital gains. The bankruptcy should have eliminated the forgiven debt income: bankruptcy is an exception to having to pay tax on forgiven debt in the event the property is worth less than the amount owed. Insolvency likewise is an exception to paying tax on forgiven debt, but insolvency is not an exception to capital gains.

Since you have been/should have been depreciating the property on your prior year tax returns, doing so adjusts your tax basis downward for that property. Therefore, if the adjusted sales price is more than your adjusted tax basis, you will have a reportable capital gain. You should consult with a CPA because the calculation of the adjusted sales price and your adjusted tax basis (the critical components in the calculation of recognizable gain) is intricate.

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Answered by: Michael A. Gillen, CPA, is director of the tax accounting department at Duane Morris LLP in Philadelphia.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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