Tax Attribute Definition

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Tax Attribute Definition

What Is a Tax Attribute?

Certain losses, tax credits, and the adjusted basis of property must be lowered since debt cancellation is excluded from a taxpayer’s total income. When a taxpayer becomes insolvent or files bankruptcy, his or her tax characteristics are changed.

Key Takeaways

  • Tax characteristics are unique economic advantages, such as tax credits, that must be lowered by the amount of debt canceled that is not included in income.
  • Tax characteristics are classified into seven sorts, including net operating losses, capital losses, and passive activity losses.
  • The IRS does not require that debt forgiveness be reflected in taxable gross income.
  • Gains from debt discharge are not included in taxable income.
  • The insolvent or bankrupt taxpayer must forego some tax attribute advantages in return for advantageous tax treatment.

How Tax Attributes Work

According to the income regulations for debt cancellation (COD), canceled debt is not taxed if:

  • In bankruptcy, the debt was discharged.
  • The debtor is bankrupt, with obligations exceeding assets, but only to the level of insolvency.
  • The loan was forgiven as a gift or inheritance from a friend or family.

Individual and company taxpayers who have their debts forgiven owing to insolvency or bankruptcy are not required to include the forgiven debt in their taxable gross income. However, the debt discharged results in a cash benefit. The Internal Revenue Service (IRS) taxes most financial gains produced by individuals and corporations using standard taxation rules. In this scenario, Section 108 of the Internal Revenue Code (IRC) exempts profits from forgiven debt from being included into taxable income, affording some relief to those taxpayers who are in extreme financial trouble.

  Windfall Tax Definition

The amount excluded from gross income, on the other hand, is utilized to decrease certain tax characteristics. Excluding income under Section 108 allows a taxpayer to postpone his or her tax due by reducing certain tax characteristics that would otherwise be available to offset future income dollar for dollar (or in certain situations, 1/3 of each dollar). In effect, when a debt is canceled, the taxpayer foregoes certain tax attribute advantages in return for gaining advantageous bankruptcy status.

According to the Internal Revenue Code (IRC), taxpayers must eliminate seven tax characteristics in the following order:

Before decreasing the other tax characteristics, taxpayers may utilize IRS Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness to decrease the basis of depreciable assets.

Example of a Tax Attribute

For example, if a taxpayer forgives $5,000 in debt, they may choose to have the basis (cost price) of their rental property lowered by $5,000 and postpone the tax until the property is sold. Reducing an asset’s cost basis indicates that a taxpayer will register a larger taxable gain (or a smaller loss) on the asset’s sale. If the property is sold for a profit, $5,000 of the profit is taxed as regular income.

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