Bankruptcy with Rent Houses
Besides the loss equity, the bankrupty of someone who owns rent houses is the classic example of a significant tax problem. If not carefully done, the owner of the rent houses could be left in a position that is worse that when he started.
The reasons is that rent houses are normally held for long periods of time and depreciated, or they are fully encumbered with liens. If the owner files a chapter 7 and discharges all of the debt against the rent houses and they pass through the bankruptcy because they have no equity, the will suffer the basis reduction that is set forth in Section 108 and Section 1017 of the Internal Revenue Code. He then ends up owning rent houses that have no tax basis at all and as soon as they are foreclosed the entire amount of the foreclosure bid price becomes taxable income.
It is for this reason that the owner of rent houses should take extreme care to make certain that the bankruptcy attorney that he chooses is well versed in the basis reduction problem and how to avoid it. It can be avoided if timed precisely and carefully done. Done properly the owner can have his fresh start without the tax burden.