11.6 Other Recovered Deductions

The rules in the preceding section (11.5) for determining whether a refund of state sales tax is taxable also apply to the recovery of other items for which you claimed a tax deduction, such as a refund of real estate taxes (16.1) adjustable rate mortgage interest (15.1), reimbursement of a deducted medical expense (17.4), a reimbursed casualty loss (18.2), a return of donated property that was claimed as a charitable deduction (14.1), and a payment of debt previously claimed as a bad debt (5.33).

Unused tax credit in prior year.

If you recover an item deducted in a prior year in which tax credits exceeded your tax, you refigure the prior year tax to determine if the recovery is taxable. Add the amount of the recovery to taxable income of the prior year and refigure the earlier year tax based on the increased taxable income. If the recomputed tax, after application of the tax credits, exceeds the actual tax for the earlier year, include the recovery in income to the extent the recovery reduced your tax in the prior year. The recovery may reduce an available credit carryforward to the current year.

Alternative minimum tax in the prior year.

If you were subject to the alternative minimum tax (AMT) in the year the recovered deduction was claimed, recompute your regular and AMT tax for the prior year based on the taxable income you reported plus the recovered amount. If inclusion of the recovery does not change your total tax, you do not include the recovery in income. If your total tax increases by any amount, the recovered deduction gave you a tax benefit and you must include the recovery in income to the extent the deduction reduced your tax in the prior year. The recovery may reduce a carryforward of a tax credit based on prior year AMT.

Recovery of previously deducted items used to figure carryover.

A deductible expense may not reduce your tax because you have an overall loss. If in a later year the expense is repaid or the obligation giving rise to the expense is cancelled, the deduction of that expense will be treated as having produced a tax reduction if it increased a carryover that has not expired by the beginning of the taxable year in which the forgiveness occurs. For example, you are on the accrual basis and deducted but did not pay rent in 2011. The rent obligation is forgiven in 2012. The 2011 rent deduction is treated as having produced a reduction in tax, even if it resulted in no tax savings in 2011, if it figured in the calculation of a net operating loss that has not expired or been used by the beginning of 2012, the year of forgiveness. The same rule applies to other carryovers such as the investment credit carryover.