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What are the income tax consequences with IRS if I do a Deed in Lieu with lender of my rental property?

Los Angeles, CA |

I was discharged from Chapter 7 Bankruptcy and surrendered my rental properties. The properties are upside down and I wish to do a Deed in Lieu with the lenders. Will I still be liable for income tax for on the deficiency even though I was discharged from bankruptcy?

What if the property is not upside down? Will IRS look at it as income and demand tax?

Attorney Answers 3

  1. One is not generally liable for income tax on a deficiency; rather, you're thinking of income tax as a result of cancellation of debt ("COD"). Bankruptcy is an exception to liability for cancellation of indebtedness income because Chapter 7 results in cancellation of all of your debt. If not, then the average debtor with $15,000 of credit card liability would discharge that and have $15,000 of phantom income on which to pay tax and that wouldn't make sense for most debtors.

    Your obligation to pay the mortgages on the rentals ceased when you obtained your discharge. You can deed the properties back to the lender or allow the lender to foreclose. The result is the same: you should have no liability to either the lender(s) or the IRS as a result of the surrender of your rentals and your Chapter 7 discharge.

    Although I'd welcome an attorney/client relationship with you, my comment here does not create one. Our firm is a debt relief agency. We help people file for bankruptcy under the United States Bankruptcy Code.

  2. Look at IRS Form 982 about canceling "phantom income" from a 1099-C.

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