Monroe, Tax II, Spring 2014
Part I: THE ROLE OF DEBT IN COMMERCIAL TRANSACTIONS
A. The Annual Tax Accounting Period
Ø Burnet v. Sanford & Brooks— In general, income tax works on an annual accounting system. As opposed to a transactional system, where you would tax on the transaction as a whole.
¨ Administrability; and
¨ Gives the government a steady reliable source of revenue
B. Loans and Cancellation of Indebtedness Income
Ø Kirby Lumber— repaying a debt for less than issue price (partial discharge of debt) frees up assets previously unavailable, and is therefore taxable gain.
Ø GENERALLY:
¨ Discharge of indebtedness income is part of gross income. § 61(a)(12); BUT…
Ø EXCLUSION FOR DISCHARGE OF INDEBTEDNESS OF THE TAXPAYER*
¨ Indebtedness of the taxpayer includes nonrecourse indebtedness for purposes of this exclusion. 108(d)(1)(B)
¨ Only in the following circumstances:
X Discharge occurs in a title 11 case. § 108(a)(1)(A)
o Title 11 Case=case under title 11 of USC, relating to bankruptcy, only if taxpayer under jurisdiction of the court in that case and d/c is granted by the court or pursuant to plan approved by the court. 108(d)(2)
o Hierarchy note: Takes precedence over and disables all other exclusions. 108(a)(2)(A)
o Corresponding reduction of tax attributes applies. 108(b)(1)
X Discharge occurs while taxpayer insolvent. 108(a)(1)(B)
o Insolvent=liabilities (-) FMV of assets. 108(d)(3)
· Insolvency and amount of insolvency determined based on assets and liabilities immediately before d/c. 108(d)(3)
o Amount of exclusion limited to amount by which taxpayer is insolvent. 108(a)(1)(3)
o Hierarchy note: Takes precedence over qualified farm indebtedness and qualified real property business indebtedness. Doesn’t apply to the extent of insolvency. 108(a)(2)(B)
o Corresponding reduction of tax attributes applies. 108(b)(1)
X Indebtedness is qualified farm indebtedness. 108(a)(1)(C)
o Corresponding reduction of tax attributes applies. 108(b)(1)
X Qualified real property biz indebtedness. (Except C corps.) 108(a)(1)(D)
¨ Rules for reduction of tax attributes
X Applies in the following order, per 108(b)(2):
o Net Operating Loss for the year of discharge and any carryover for that year. 108(b)(2)(A)
o General business credit. 108(b)(2)(B)
o Minimum Tax Credit. 108(b)(2)(C)
o Capital Loss Carryovers under 1212. 108(b)(2)(D)
o **Basis Reduction** taxpayer’s property. 108(b)(2)(E)(i)
· Basis reduction done per rules in 1017. 108(b)(2)(E)(ii)
o **Passive Activity Loss** for the year or credit carryover under 469(b) for year of discharge. 108(b)(2)(F)
o Foreign Tax Credit Carryovers. 108(b)(2)(G)
¨ Certain people acquiring your debt will be treated as you buying your own debt
X Usually if someone buys your debt, it doesn’t change anything because you still have to pay somebody back the full amount. But if certain types of relations acquire the debt, defined in 267(b), it’s treated as you acquiring the debt, and therefore you may have income from the discharge of indebtedness. 108(e)(4)(A)
o 267(b) relations—
· (b)(1)—members of family, as
roperty received
¨ § 1001(c)—
X Recognized Gain= entire amount of gain or loss, unless otherwise provided.
¨ § 1011(a)—
X Adjusted Basis= Basis
¨ § 1012(a)—
X Basis= Cost (unless otherwise provided)
Ø Crane—Crane inherits apartment building from husband. Building had an outstanding nonrecourse loan attached to it. Building worth about 260k, balance of loan around 260k too. She holds it for a period of years, keeps taking depreciation deductions. Banks prepares to foreclose, so she sells it for 3k, and purchaser takes the nonrecourse liability. She takes 2500 in cash, while 500 went to the transaction costs. Crane wants 2500 gain. Government argues for the debt relief to be included in the gain.
¨ Amount realized includes debt relief
¨ Basis includes acquisition indebtedness
¨ [In this case, the FMV was greater than the debt, so the only way she could access the equity was by paying off the loan. FN 37 left the question of FMV Tufts answered the open “economic benefit” question.]
Ø Tufts—Tufts borrows 1.85m, nonrecourse, to buy property. Takes some depreciation deductions. Property fails. FMV goes down to 1.4m, A/B down to 1.45m after the deductions. Tufts transfers the property for no consideration other than assumption of the nonrecourse liability.
