Question

Charlie's vacation cabin was secured by a nonrecourse mortgage. this year, the bank foreclosed on the property. at the time of the foreclosure: the principal balance of the loan was $200,000; the cabin's fair market value was $150,000; and charlie's adjusted basis was $220,000. charlie received no money or other property as part of the transaction. which of the following correctly describes the income, gain, or loss that charlie realized as a result of this foreclosure?

O ordinary income of $70,000 and capital loss of $50,000.
O ordinary income of $50,000 and capital loss of $70,000.
O capital gain of $50,000.
O capital loss of $20,000.

Answer 1

The correct answer is: Charlie realized a capital loss of $70,000. Charlie had a nonrecourse loan foreclosed with a principal balance of $200,000 and fair market value of $150,000, leading to a capital loss of $70,000, as the debt cancellation does not constitute income and no money was received.

Step-by-step explanation:

Charlie had a nonrecourse mortgage on his vacation cabin, which was foreclosed on. At the time of foreclosure, the loan's principal balance was $200,000, but the fair market value of the cabin was only $150,000. Charlie's adjusted basis in the property was $220,000, and he received no money or other property as part of the foreclosure.

In a foreclosure, the cancellation of debt up to the fair market value of the property is generally not considered income under a nonrecourse loan because the lender can only seize the collateral. Here, the fair market value is $150,000, and thus, Charlie would not have ordinary income regarding the cancellation of debt up to this amount. Instead, the difference between the canceled debt ($200,000) and the fair market value ($150,000) is treated as the sale price in a deemed sale for income tax purposes.

Charlie's capital loss is determined by subtracting the deemed sale price of the property ($150,000) from his adjusted basis ($220,000), which results in a capital loss of $70,000. Since the canceled debt does not result in income due to the nonrecourse nature of the loan, Charlie does not have ordinary income from the cancellation, and only the capital loss is recognized.

Therefore, the correct answer is: Charlie realized a capital loss of $70,000.

Answer 2

Charlie realizes a capital loss of $20,000 from the foreclosure of his vacation cabin with a nonrecourse mortgage, since the loss is the difference between the property's adjusted basis ($220,000) and the loan balance ($200,000). There is no ordinary income or capital gain involved in this transaction.

Step-by-step explanation:

The question pertains to the determination of income, gain, or loss realized by Charlie as a result of the foreclosure of his vacation cabin. When a bank forecloses on a property with a nonrecourse mortgage, the amount realized by the borrower is the remaining balance of the loan, since the borrower is not personally liable for the debt beyond the collateral (in this case, the cabin). In this scenario:

• The principal balance of the loan is $200,000.
• The cabin's fair market value is $150,000.
• The adjusted basis of the property is $220,000.

Considering that the loan balance exceeds the property's fair market value, it is the loan balance that is used to determine the amount realized. Therefore, Charlie has neither ordinary income nor capital gain because the mortgage was nonrecourse and the foreclosure sale is treated as a sale or exchange. The loss is the difference between the property's adjusted basis and the amount realized (loan balance), which is $220,000 - $200,000 = $20,000. Thus, Charlie has a capital loss of $20,000.