OT/Legal/Tax question

I was laying awake last night thinking about all of the repo and forclosure auctions that I went to in the 80s during the "farm crisis" and thought of something I hadn't thought about before.

If a bank,of farm credit service has a blanket on all of your equipment and reposeses it,then sells it at auction,are you liable for capital gains taxes on the sale of that equipment? At first glance,I'd say no. It wasn't your stuff when they sold it. But on the other hand,you were effectivly using that equipment to pay toward a loan that you were liable for,the same as if it was cash. The value just wasn't determined until it was sold. So,how about it? Would it be taxable or would it be the equivilent of giving it away?

Randy, in my area a few farmers had some taxes levied on the write down on their ag loans. Bill

I believe you are responsible for the loss/gain incurred on the loan. as mentioned if you have a write down on a loan it is considered income. face it they get you coming and going

Good question! I know just enough to be dangerous about this stuff.

On one side, I would say no. They can't sell what is not theirs, so that they first exercise their option to repossess, giving them title to sell the goods. Generally, any tax liability or benefit would fall on the lender for any gain or loss in the sale, relative to the amount outstanding on any loan. $$ they get in excess of the loan amount are taxable income. Anything less can be deducted as a loss.

But that's where I start to get fuzzy.

1) I don't know whether the cost basis for any gain or loss in the sale takes into consideration any depreciation that the debtor might have claimed, or merely the lender's investment.

2) Real property and equipment are treated differently in the tax code, even though both ofen involve loans. If the bank agrees to a short sale (NOT part of a foreclosure) of a piece of real estate, the difference between what was owed and what the property sold for is considered to be a forgiveness of a loan, and that amount is taxable to the borrower. (Idea being that the bank deducts the loss, the borrower pays tax on the forbearance/forgiveness.) In a foreclosure, which is akin to repossession of equipment and not a forgiveness of some part of the loan, I don't know if the borrower is off the hook or not. My suspicion is that they are. The bank is obliged to pay some part (after costs of the sale) of anything they get in excess of the amount of the debt back to the borrower, and that is taxable as a capital gain only if the sale price exceeds the original purchase price.

I've probably only complicated things and my head is starting to hurt, so I'll stop now.

There are at least 2 attorneys who regularly post on 'here'; maybe they'll chime in.....

Uncle found out that after closing auction the total sale amount was considered income for that year- state wanted income tax for total amount. Another guy went through bankruptcy and got retirement fund in lump sum- next year state and federal were garnisheeing wages for fail to pay income tax. Law was changed to have 10 to 20% of early retirements withheld as tax. If it possibly can be taxed under some code- figure it will be. RN

IRS would treat it as a sale. You would compare your basis in the goods at the time of sale, to what you "received" from the sale. Basis is the amount of value left in the goods for tax purposes, generally cost less depreciation. What you "received" is the amount of reduction of the loan (plus excess funds, if it sold for more than was owed). If the stuff brought more at the sale than its basis, you're on the hook for capital gains tax on the difference.

The "imputed income" situation that Scotty brought up only came into play when you turned over the equipment or real estate in full satisfaction of the debt. They, you would be taxed on the amount of loan forgiveness that was above and beyond the fair market value of the stuff. Some exceptions generally kept folks out of that situation- if you were insolvent, or in bankruptcy, it didn't apply, and many were in that situation by the time such drastic measures as foreclosure occurred.

Even though this seems unfair (kicking you while you're down, so to speak), it was generally advantageous from a financial standpoint. If you had a loan of $100,000, and bank accepted R/E worth $75,000 in full satisfaction, you'd owe tax on $25,000- lets say, 4 grand. However, if bank just did a sale and applied the proceeds, you'd still owe 25 grand.

The most cruel application of the rule is when you tried to be a good guy and give the bank a "deed in lieu of foreclosure" voluntarily, instead of making them go through the foreclosure process. Thanks for doing the right thing, and by the way, Surprise! You owe some tax!

Happy to say, the "imputed income" rule has been suspended by IRS, beginning in 2007, and on into the forseeable future (translation- until economy gets back on its feet, and they can resume taxing the daylights out of us).

Actually, Uncle would have to pay ordinary income tax on the difference between his undepreciated basis at the time of the sale, and the original cost of the stuff ("recapture" of depreciation); and long term capital gains tax on any proceeds above his original purchase price. What with fast depreciation, and the fact that probably lots of the stuff was old and depreciated out, he probably did have to pay tax on pretty much the whole amount.

Been all thru this. The hard way.

You can forget the "loss/gain" thing.

Every penny realized on the sale is considered straight "income" and you are responsible for paying taxes on it. Federal and state if your state law applies.

You can deduct the auction fees tho. :>(

Allan

Wow,I would think you would at least be able to use your basis and just pay capital gains. Straight income tax is even worse. You would have to pay Social Security on that too then wouldn't you?

Would it make a difference if the check was made out to the bank? I had an old guy tell me many years ago [50s] he had sold grain and had the check made out to the bank and not himself He took the check to the bank and put it towards his note. he did not have to pay the taxes the bank did . But it only worked 1 time and then the bank made sure when checks were made out his name got on them also.

Mike has covered the topic well. I think he made one error though, fully depreciated equipment is subject to depreciation recapture rules and would be considered "ordinary" income" subject to regular income tax - not capital gains.

A simple example. You have a tractor you paid $10,000 for in 1991. Its fully depreciated so it has a book value of "$0". The bank takes it to cover a $13,000 loan. The tractor sells for $12,000 at auction. The farmer has $10,000 of depreciation recapture also called section 1031 - taxed at 25%. He has a $2,000 capital gain (currently taxed at 10%) and he has a $1000 of dept forgiveness - taxed at regular rates.


You'll be subject to all taxes unless debt is discharged though bankruptcy.

Last word of advice - NEVER USE A LAWYER FOR TAX ADVICE!!!!!! I've seen more estates and bsinesses screwed up because of lawyers then I ever dreamed possible.

No.

My mistake - Mike does cover depreciation recapture.

Got any idea 'who/what' Mike is?

I'm an attorney who was previously a loan officer for Farm Credit Services- have seen all this stuff from both ends- don't claim to have all the answers, but have a lot of them, "even if I do say so myself". I'm pretty confident in what I put in my original answer.

Knew that, Mike; assumed that dhermesc didn"t..........