Distribution of an asset with $0 value

[Guest Dave Peckham]

Client under age 59-1/2 has real estate in a PSP encumbered by a mortgage. Value of real estate has fallen to below what the mortgage balance is. CPA suggests a premature distribution of BOTH the real estate and the mortgage. Since there is no equity, he proposes that the taxable amount of the premature distribution is $0. Thus there is no premature distribution penalty either. The reason for doing this is to gain some tax advantages in the negative cash flow if the real estate is held personally, rather than in the plan.

It doesn't appear that this distribution would be a prohibited transaction. Anybody see any problems with this?

[mbozek]

Client under age 59-1/2 has real estate in a PSP encumbered by a mortgage. Value of real estate has fallen to below what the mortgage balance is. CPA suggests a premature distribution of BOTH the real estate and the mortgage. Since there is no equity, he proposes that the taxable amount of the premature distribution is $0. Thus there is no premature distribution penalty either. The reason for doing this is to gain some tax advantages in the negative cash flow if the real estate is held personally, rather than in the plan.

It doesn't appear that this distribution would be a prohibited transaction. Anybody see any problems with this?

If the FMV of the property is 0 then that is what should be reported on the 1099 but deducting the outstanding mortgage is an accounting Q. Check instructions for 5329 form. However, assets held in a Q plan are subject to UBIT if they are debt financed. See Pub 598, P 14. If the client's account in PSP was receiving income over $1000 per year from the debt financed property UBIT may have applied.