Gain or Loss on Reacquisition of Real Property

In a recent discussion, you describe circumstances in which you have been forced to repossess real property due to the buyer's default. The following is a brief description of the basic rules concerning the recognition of gain or loss on the reacquisition of real property.

Generally, a seller, who has retained a security interest in the real property sold and then repossesses the property as a result of the buyer's default, cannot recognize a loss from the requisition. Nor can you, the seller, treat the debt secured by the property as worthless as a result of the repossession. In addition, gain on the reacquisition is limited to the money and fair market value of other property received by you to the extent that these amounts have not been reported in income. Gain is further limited to the amount realized from the original sale, reduced by amounts already reported in income and amounts paid by you in connection with the reacquisition of the property. Thus, the recognized gain is limited to the amount by which the sales price of the real property exceeds the property's adjusted basis (i.e., the gain on the original sale), less the amount of gain on the original sale that was reported as income before the reacquisition, and the amount of money and the fair market value of the other property paid or transferred by you in connection with the reacquisition.

After determining the amount of recognized repossession gain received, that gain must be characterized for tax treatment. The character assigned is based on whether the gain on the original sale was returned on the installment method or, if not, on whether the title to the real property was transferred to the purchaser. The repossession gain has the same nature as the gain reported on the original sale if it was reported on the installment method. If the title was transferred to the purchaser and you accepted a voluntary reconveyance of the property, i.e., a deferred payment sale, the gain is ordinary income. If, however, the purchaser's obligation was considered a "security," your resulting gain on the reacquisition is capital gain.

An additional issue that arises in the reacquisition of property concerns the calculation of the property's new basis. The basis of your reacquired property is the adjusted basis of the buyer's debt to you, increased by any gain from the reacquisition, plus the amount of money and the fair market value of any other property you paid in connection with the reacquisition of the property.

Note that if the property you reacquired was formerly your principal residence, and you did not recognize gain on the sale of such principal residence, then no gain or loss results from the reacquisition if you resell the repossessed property within one year.