Individual bankruptcy regulations provide guidance.

AuthorRosenberg, Neil

When an individual files for bankruptcy protection a new taxable entity is created - the bankruptcy estate (the "estate"). The estate becomes a separate taxpayer required to compute its taxable income, elect a tax year, pay any tax and file tax returns. The individual and the estate are two distinct entities for tax purposes. Sec. 1398(g)(1) through (8) provide that the estate will succeed to a specific list of the debtor's tax attributes, including: * Net operating losses. * Charitable carryovers. * Tax benefit items. * Credit carryovers. * Capital loss carryovers. * Basis, holding period and character of assets. * Method of accounting. * Other tax attributes, to the extent provided for by regulations.

Before Nov. 9, 1992 no regulations were issued to provide for carryovers of passive activity losses (Sec. 469) or losses limited by the at-risk rules (Sec. 465).

On Nov. 9, 1992, Prop. Regs. Secs. 1.1398-1 and 1.1398-2 were issued. Prop. Regs. Sec. 1.1398-1 provides that the bankruptcy estate succeeds to the debtor's unused passive activity losses and credits. Likewise, Prop. Regs. Sec. 1.1398-2 provides that the estate succeeds to any losses of an individual debtor that were limited by the at-risk rules of Sec. 465.

These regulations end a significant issue of concern for tax practitioners who advise bankrupt debtors or their creditors. Many estates have assets encumbered by debts that will result in taxable gain if the asset is turned over to a creditor or sold to third parties. Since any tax created during the administration of the estate is a priority claim (which must be paid before general creditors), the ability to carry over the passive activity losses can make the difference between a viable plan of reorganization (Chapter 11) or a complete liquidation (Chapter 7).

If, before the termination of the estate, the estate transfers a passive activity to the debtor (other than by sale or exchange), the transfer will not be treated as a disposition and the portion of the passive activity loss attributable to the activity will also return to the debtor (Prop. Regs. Sec. 1.1398-1(d)(1) and (2)). The abandonment of an asset back to a debtor prior to the termination of the case is provided for under bankruptcy law (11 U.S.C. Section 554) on notice that the property is burdensome to the estate or is inconsequential in value. If the debtor then sells the property or it is taken in foreclosure, the debtor will have the passive...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT