Income Tax Liability In Bankruptcy For Appreciated Property

by Zach Haris

People avoid filing Chapter 7 bankruptcy if they have the nonexempt property with significant equity. Yet, consider a debtor who owns real estate that has appreciated and therefore has a built in liability for capital gain. If that debtor files bankruptcy could the IRS hold him personally liable after bankruptcy for the income tax liability associated with the gain on the property?

When a person files bankruptcy all of his property interest is transferred to the Chapter 7 trustee and the property constitutes the bankruptcy estate. The trustee acquires the debtor’s property with its tax characteristics including gain and character. The trustee controls the sale of the property, and the trustee receives the sales proceeds for the benefit of creditors.

The trustee and the bankruptcy estate is liable to pay the tax liability created by the sale of the debtor’s property. The tax is an administrative expense. The debtor is not liable for tax on the sale of property he had conveyed to the bankruptcy estate upon filing bankruptcy. A trustee may avoid tax liability by abandoning the property instead of selling it.

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