Figuring taxes on failed installment sale

Dear Tax Talk,
I wonder if anyone would be so kind as to help me with a 2011 tax question. I am a widow on a fixed income and trying to do my taxes myself — as I have the last couple of years.

However, 2011 poses a situation I can’t find information on. I’m perplexed.

I live in South Carolina. I sold a rental condo in South Carolina to a lady in California four years ago. She paid $18,500 down (went to commission), and I took back a first mortgage (owner-financed) for $50,000. She kept the same renter, collected rent and paid me mortgage payments.

In November 2010, her renter defaulted. In early 2011, she advised she could no longer make mortgage payments to me and couldn’t manage the property from the West Coast.

I agreed to take the property back by deed in lieu of foreclosure. It cost me $1,000 in attorney fees to get the property back.

I had to finish the eviction of the tenant. The property was basically destroyed by the tenant, who was judgment proof, so that was not an option. After four months of homeowners association fees, repairs and renovations ($6,000 total), with no off-setting rental income, I finally rented it in August 2011.

The balance on the mortgage when I accepted the deed-in-lieu was $48,000. The property values have dropped dreadfully, and it’s only worth about $30,000 to $35,000 max.

• Do I have any kind of write-off for the value of the mortgage balance ($48,000) versus the declined value of the property ($35,000 max) and the $6,000 I paid out to get it rentable?
• Do I have to file any kind of paperwork evidencing the deed-in-lieu (I’ve read all I can, and I see a 1099-C or something — but have no idea).
• How do I figure my cost basis on this? Is it $48,000 plus $6,000? Where does the fair market value, or FMV, figure in? I don’t have a paid appraisal — only comps I pulled myself.

If you can, and would, any information would be helpful — and I assure you, I will take the info as suggestions only, not tax advice, to a person (me) that needs to be in a retirement home — not handling real estate I thought I got rid of. If you can’t answer or suggest, maybe you can direct me to some info (in layman’s language).

Thank you so much for anything you can shed on this.
— Hope

Dear Hope,
You do have quite a bit of complex tax issues involved. You may want to hire a professional rather than do it yourself. If you want some guidance in layman’s terms, the IRS publication that discusses your issue is Publication 537, Installment Sales. An installment sale is a seller-financed sale of property where payments will be received after the close of the tax year. As the seller financing the sale of the property, you should have used the installment sale rules to report any gain.

Worksheets D and E on Page 13 of the publication will guide you through computing any gain on the repossession. You cannot recognize loss on the repossession of the property, so even though the value is less than the $48,000 outstanding, you’ll have to wait to sell the asset before you can recognize any loss. In addition, if you did use the installment method, then the $48,000 mortgage balance may not result in additional basis in the property. This is why this is complicated. Because you’re not in the mortgage business, you’re not required to issue a 1099 to the borrower. The FMV of the property does not figure into your basis or reporting any gain on the repossession.

Ask the adviser

To ask a question on Tax Talk, go to the “Ask the Experts” page and select “Taxes” as the topic. Read more Tax Talk columns.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Bankrate’s content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate’s Terms of Use.