02 Feb 2016

When is the Right Time to Marry the Sale of Real Property with a Bankruptcy Estate Tax Return?

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The sale of over-encumbered real property assets is the fastest growing transaction type by savvy Chapter 7 trustees seeking opportunities to increase the return to the bankruptcy estate and its creditors. The decision on whether to pursue the sale of real property in bankruptcy is often met with concern as to whether a tax return will be required; often limiting the decision to monetize real property assets.

If you are thinking about monetizing an estate’s real property assets through a sale, you may be wondering when is the right time to marry the sale of real property with the filing of a tax return for the bankruptcy estate. If a real property sale is an equity, short sale, or deed in lieu of a 363(k) transaction, you generally do not need to file a tax return for the sale of a principal residence as long as the following specific exclusionary tests are met.

Exclusionary Tests

Chapter 7 trustees should apply these specific tests to determine if a tax return should be initiated, including a review of ownership, use, and frequency limitations:

  1. Ownership Test: the debtor(s) has owned the principal residence for at least two out of the five years prior to the sale.
  2. Use Test: the debtor(s) use of a principal residence, included at least two out of the five years prior to a sale. The two years of use does not have to be consecutive.
  3. Frequency Test: allows for only one primary residence sale every two years.

If a debtor has met all of the exclusionary tests outlined above, the gain on the sale of a principal residence may be excluded up to $250,000 per individual debtor, and there is no need to file a tax return.

Conditions that Require the Filing of a Tax Return

The following conditions require that a tax return be filed:

  • If the debtor(s) owns real property assets that are considered either a vacation home or an investment property, capital gains will need to be calculated on the sale of the assets, and a bankruptcy estate tax return must be completed.
  • If the bankruptcy estate receives any tax documents related to the sale—such as a 1099‐S—a tax return should be filed. The Internal Revenue Service will receive a copy of the 1099‐S and will expect a return to be filed.

The principal residence exclusion including the tests listed above can be found in the Internal Revenue Code §121.

No Charge Assessment for Estates of BMS Clients

If you are considering the sale of real property out of a bankruptcy estate, Trustee Resource Group is offering BMS clients an initial assessment on whether the estate should file a tax return at no charge. Cheryl Wesler, from Trustee Resource Group, is a CPA and has worked with Chapter 7 trustees nationwide. Her contact information is:

Cheryl Wesler, CPA
Trustee Resource Group
(269) 342‐9482 ext. 2