[Federal Register Volume 63, Number 204 (Thursday, October 22, 1998)]
[Rules and Regulations]
[Pages 56559-56565]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-28263]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 301, and 602
[TD 8787]
RIN 1545-AU71
Basis Reduction Due to Discharge of Indebtedness
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final and temporary regulations that
provide ordering rules for the reduction of bases of property under
sections 108 and 1017 of the Internal Revenue Code of 1986. The
regulations will affect taxpayers that exclude discharge of
indebtedness income from gross income under section 108.
DATES: Effective Date: These regulations are effective October 22,
1998.
Applicability Date: These regulations apply to discharges of
indebtedness occurring on or after October 22, 1998 and to elections
under section 108(b)(5) concerning discharges of indebtedness occurring
on or after October 22, 1998.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations generally,
Sharon L. Hall or Christopher F. Kane of the Office of Assistant Chief
Counsel (Income Tax & Accounting) at (202) 622-4930; concerning
partnership adjustments under section 1017, Matthew Lay of the Office
of Assistant Chief Counsel (Passthroughs & Special Industries) at (202)
622-3050.
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in this final regulation
have been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 1545-1539. Responses to these collections
of information are required to obtain a benefit.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated annual burden per respondent is 1 hour.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This final regulation contains amendments to the income tax
regulations (26 CFR Parts 1 and 301) under sections 108 and 1017 of the
Internal Revenue Code of 1986 (Code). The amendments conform the
regulations to amendments to sections 108 and 1017 made by the
Bankruptcy Tax Act of 1980, Public Law 96-589, Secs. 2, 94 (Stat. 3389
(1980)); 1980-2 C.B. 607 (Bankruptcy Tax Act); the Technical
Corrections Act of 1982, Public Law 97-448, Sec. 102(h)(1), 96 (Stat.
2365, 2372 (1983)); 1983-1 C.B. 451; the Deficit Reduction Act of 1984,
Public Law 98-369, sections 474(r)(5) and 721(b)(2), 98 (Stat. 494,
839, 966 (1984)); 1984-3 C.B. (Vol. 1) 1; the Tax Reform Act of 1986,
Public Law 99-514, sections 104(b)(2), 231(d)(3)(D), 822, and
1171(b)(4), 100 (Stat. 2085, 2105, 2179, 2373, 2513 (1986)); 1986-3
C.B. (Vol. 1) 2; and the Omnibus Budget Reconciliation Act of 1993,
Public Law 103-66, section 13150, 107 (Stat. 312, 446 (1993)); 1993-3
C.B. 1.
On January 7, 1997, proposed regulations (REG 208172-91), were
published in the Federal Register (62 FR 955). Written comments were
received in response to the notice of proposed rulemaking. One speaker
provided testimony at a public hearing held on May 29, 1997.
After consideration of all the comments, the proposed regulations
under sections 108 and 1017 are adopted, as revised by this Treasury
decision.
Explanation of Revisions and Summary of Comments
1. Basis Reduction Limited to Fair Market Value
One commentator requested that basis reduction be limited to fair
market value as provided by Sec. 1.1016-7(a) (as removed by this
regulation). The final regulations do not adopt this recommendation.
Section 1017, as enacted by the Bankruptcy Tax Act, fundamentally
changed the rules relating to basis reduction where discharge of
indebtedness income (cancellation of debt (COD) income) is excluded
from gross income. The revised statute, in section 1017(b)(2), provides
only one limitation on basis reduction for insolvent and bankrupt
taxpayers who do not make an election under section 108(b)(5). Under
that rule, the basis reduction may not exceed the excess of the
aggregate of the bases of the property held by the taxpayer immediately
after the discharge over the aggregate of the liabilities of the
taxpayer immediately after the discharge. The fair market value
limitation found in the regulations removed by this Treasury decision
is not reflected in section 1017. Accordingly, the IRS and Treasury
[[Page 56560]]
Department do not believe that a rule limiting basis reduction to fair
market value would be appropriate.
2. Section 108(c)(2)(A) Limitation
Section 1.108-5(a) of the proposed regulations described the
limitation under section 108(c)(2)(A) and provided that the amount
excluded under section 108(a)(1)(D) (concerning discharges of qualified
real property business indebtedness) could not exceed the excess of the
outstanding principal amount of that indebtedness immediately before
the discharge over the net fair market value of the qualifying real
property (as defined under Sec. 1.1017-1(c)(1)) immediately before the
discharge. Two commentators requested that the regulations clarify that
any outstanding accrued and unpaid interest is included in determining
the outstanding principal amount of the indebtedness for purposes of
this limitation. Given the purpose of this limitation, which is to
prevent taxpayers from using the section 108(a)(1)(D) exclusion to the
extent that debt cancellation would create equity in property (H.R.
Rep. 103-111, 103d Cong., 1st Sess., 622-23 (1993)), the IRS and
Treasury Department believe that it is inappropriate to strictly limit
the exclusion by reference to the amount stated as principal in the
debt instrument. Accordingly, the final regulations provide that, for
purposes of section 108(c)(2)(A) and Sec. 1.108-6 only, outstanding
principal amount means the principal amount of an indebtedness and all
additional amounts owed that, immediately before the discharge, are
equivalent to principal, in that interest on such amounts would accrue
and compound in the future. Amounts that are subject to section
108(e)(2) are excepted from the definition of principal amount. In
addition, principal amount must be adjusted to account for unamortized
premium and discount consistent with section 108(e)(3).
3. Allocation of Basis Reduction of Multiple Properties Within the Same
Class
The proposed regulations incorporated the limitation described in
section 1017(b)(2) which provides that the basis reduction for bankrupt
and insolvent taxpayers may not exceed the excess of the aggregate of
the bases of the property held by the taxpayer immediately after the
discharge over the aggregate of the liabilities of the taxpayer
immediately after the discharge. A commentator suggested that this
limitation be applied on a class by class basis, so that when a basis
reduction applied within a single class of properties described in
Sec. 1.1017-1(a) exceeds the amount of basis over the debt secured by
the properties in that class, the basis reduction in excess of that
amount should default to the next class.
The final regulations do not adopt this comment.
The overall limitation on basis reduction is determined by
reference to the adjusted basis of property and the amount of money
held by the taxpayer over the liabilities of the taxpayer ``immediately
after the discharge.'' By contrast, under the basis reduction rules
applicable for purposes of section 108(b)(2)(E), the taxpayer must
reduce the adjusted basis of property ``held by the taxpayer at the
beginning of the taxable year following the year in which the discharge
occurs.'' Section 1017(a). Given the difference in the relevant time
for applying the basis limitation and the basis reduction rules, and
the relative complexity of the calculations necessary to implement the
proposal, the IRS and Treasury Department believe that the suggested
limitation is not workable. Accordingly, the final regulations continue
to apply the limitation based on the aggregate bases and liabilities of
the taxpayer consistent with section 1017(b)(2).
The proposed regulations also provided that a taxpayer must treat a
distributive share of a partnership's COD income as attributable to a
discharged indebtedness secured by the taxpayer's interest in that
partnership. The rule in the proposed regulations for allocating basis
reduction among multiple properties under section 108(b)(2)(E)
contained parenthetical language cross-referencing the partnership
provision for the property classes that included secured real and
personal property used in a trade or business or held for investment.
This parenthetical language was intended to remind taxpayers that
partnership indebtedness is treated as indebtedness secured by the
taxpayer's interest in the partnership.
One commentator stated that the cross-reference with respect to
secured real property was confusing since a partnership interest
presumably should be treated as personal property in reducing basis
under section 108(b)(2)(E). This is contrasted with the modified basis
reduction rules under sections 108(b)(5) and 108(c) which, assuming the
appropriate requests are made and consents are granted, apply a look-
through rule to reduce the inside basis of depreciable property or
depreciable real property held by a partnership.
In order to eliminate this confusion, the parenthetical language is
not included in the final regulations. However, as under the proposed
regulations, the final regulations continue to treat a distributive
share of a partnership's COD income as attributable to a discharged
indebtedness secured by the taxpayer's partnership interest.
Accordingly, the elimination of the parenthetical language is not
intended to change the substantive results obtained in allocating a
basis reduction among multiple properties.
4. Meaning of ``in Connection With'' in Section 108(c)(3)
A commentator requested that the final regulations provide that the
phrase ``in connection with'' in section 108(c)(3) does not require
that the proceeds of debt incurred or assumed before January 1, 1993 be
traced to real property used in a trade or business, but only requires
that the debt be secured by real property used in a trade or business
as of January 1, 1993. The final regulations do not adopt this comment.
Section 108(c)(3)(A) defines qualified real property business
indebtedness as indebtedness which ``was incurred or assumed by the
taxpayer inconnection with real property used in a trade or business
and is secured by such real property''. The IRS and Treasury Department
do not believe that this sentence should be interpreted to mean only
that the debt must be secured by real property used in a trade or
business as of January 1, 1993.
5. Basis Reduction With Respect to a Residence
A commentator requested that when the basis of a taxpayer's
residence is reduced under section 1017 and is disposed of in a
transaction subject to section 1034 (which provided for the deferral of
gain on the sale of a personal residence), the potential recapture
income arising under section 1245 should be carried into the
replacement property. This comment is not adopted in the final
regulations. Section 1034 was repealed by the Taxpayer Relief Act of
1997. New section 121, enacted by the Taxpayer Relief Act of 1997,
exempts certain gain on the sale of a residence, but does not provide
that the potential gain will be transferred to a replacement residence.
Therefore, under the new law, there is no mechanism to preserve the
potential recapture income with respect to a new residence, and the
potential recapture income must be recognized on the sale of the
residence under section 1245.
[[Page 56561]]
6. Mandatory Request and Consent
The proposed regulations provided that a partner may treat a
partnership interest as depreciable property under section 108(b)(5)
(or as depreciable real property under section 108(c)) only if the
partnership consents to make corresponding adjustments to the basis of
the partnership's depreciable property (or depreciable real property).
The IRS and Treasury Department generally believe, in this context,
that whether or not a partnership consents to make the corresponding
adjustments to the basis of its property should be a matter of
agreement between the partner and the partnership. Therefore, the
proposed regulations generally provided that a partner is free to
choose whether or not to request that a partnership reduce the basis of
partnership property and that the partnership is free to grant or
withhold its consent.
The ability to freely choose whether or not to request or grant
consent, however, provides opportunities to avoid the general ordering
rules of the proposed regulations through the use of a partnership.
Therefore, the proposed regulations provided that, in a limited number
of situations; (i) a partner is required to request the partnership's
consent, and (ii) the partnership is required to grant that consent.
Specifically, the proposed regulations provided that a partner is
required to request consent if the partner owns (directly or
indirectly) more than 50 percent of the capital and profits interests
of the partnership, or if the partner receives a distributive share of
COD income from the partnership. In addition, the partnership is
required to grant consent if requests are made by partners owning
(directly or indirectly) an aggregate of more than 50 percent of the
capital and profits interests of the partnership.
One commentator requested revisions to the mandatory request and
consent rules contained in the proposed regulations. This commentator
argued that the proposed regulations, as written, could unduly burden
certain large partnerships in situations where the partnership's
refusal to consent was not motivated by tax avoidance. The commentator
requested that the mandatory consent rule be revised to require a
partnership to consent only if the partnership receives requests from
five or fewer partners who own, in the aggregate, more than 50 percent
of the capital and profits of the partnership.
To ensure that partnerships are not unduly burdened by the
mandatory request and consent rules, the commentator's proposal has
been adopted, in part, in the final regulations. However, to preserve
the general ordering rules of the regulations, the IRS and Treasury
Department believe that it is appropriate to require a partnership to
consent to reduce the basis of its depreciable property (or depreciable
real property) where a substantial majority of its partners elect to
exclude the COD income under sections 108(b)(5) or 108(c). Therefore,
the final regulations provide that a partnership must consent to reduce
its partners' shares of the partnership's depreciable basis in
depreciable property (or depreciable real property) if consent is
requested by; (i) partners owning (directly or indirectly) an aggregate
of more than 80 percent of the capital and profits interests of the
partnership, or (ii) five or fewer partners owning (directly or
indirectly) an aggregate of more than 50 percent of the capital and
profits interests of the partnership.
As in the proposed regulations, the final regulations do not
require a partnership to reduce the basis of its depreciable property
(or depreciable real property) in all situations where the partnership
is the source of the COD income. However, where a partnership is the
source of the COD income and partners elect to exclude such income,
such partners are required to request that the partnership reduce its
basis in such property.
Accordingly, if partners meeting the requirements in (i) or (ii)
above elect to exclude such income, the partnership must consent to
reduce the basis of its depreciable property (or depreciable real
property).
Commentators also requested that the final regulations clarify that
a partnership's consent is not required for basis adjustments under
section 108(b)(2)(E). The final regulations make it clear that a
partnership's consent to reduce the basis of the partnership's
depreciable property (or depreciable real property) is neither required
nor relevant where a partner reduces the basis in its partnership
interest under section 108(b)(2)(E).
7. Treatment of the Adjustment to the Basis of Partnership Property
Under Subchapter K
One commentator requested that the final regulations address a
number of issues concerning the treatment of the partnership's
adjustments to the basis of partnership property under subchapter K.
The final regulations do not address these issues. Instead, the IRS and
Treasury Department have addressed these issues in the proposed
regulations recently promulgated under sections 743 and 755.
8. Timing and Reporting
The proposed regulations provided that a partner requesting a
reduction in inside basis must make the request and receive consent
before the due date (including extensions) for filing the partner's
Federal income tax return for the taxable year in which the partner has
COD income. The proposed regulations also provided that a partnership
that consents to a basis reduction must include a consent statement
with its Form 1065, U.S. Partnership Return of Income, and provide a
copy of that statement to the affected partner on or before the date
the Form 1065 is filed. One commentator stated that the final
regulations should provide that; (i) partners should not be required to
request consent, and (ii) neither the partner nor the partnership
should be required to attach statements to their returns, until the
filing date of their respective returns for the taxable year following
the year that the partner excludes COD income.
The IRS and Treasury Department continue to believe that a partner
electing under sections 108(b)(5) or 108(c) must receive the consent of
the partnership before the partner excludes the COD income. Therefore,
the final regulations provide that the partner must request and receive
the consent of the partnership prior to the due date (including
extensions) for filing the partner's Federal income tax return for the
taxable year in which the partner has COD income. The final regulations
do, however, adopt the commentator's suggestion that the partnership is
not required to attach a statement to its return until the filing date
of its Federal income tax return for the taxable year following the
year that ends with or within the taxable year that the partner
excludes the COD income.
The commentator also stated that the final regulations should
provide that when a partnership recognizes any COD income from
qualified real property business indebtedness it should attach a
statement to its partners' Forms K-1 stating that the COD income is
from qualified real property business indebtedness and the date the
cancellation occurred. The final regulations do not adopt this
proposal. The IRS and Treasury Department believe that Sec. 1.703-
1(a)(1) currently requires partnerships to separately state qualified
real property business indebtedness and identify it as such.
The IRS and Treasury Department recognize that a partner might not
always have sufficient information with which to decide to request a
basis reduction until on, or shortly before, the
[[Page 56562]]
due date (including extensions) for filing the partner's Federal income
tax return. Therefore, comments were requested as to whether additional
rules (such as requiring a partnership to inform partners of COD income
prior to the date the Form 1065 is filed) are necessary to ensure that
information is exchanged between the partnership and its partners in a
timely fashion. The final regulations do not require partnerships to
inform their partners of COD income prior to the date the Form 1065 is
filed. Instead, the IRS and Treasury Department believe that any
additional administrative burdens imposed on partnerships should be the
result of an understanding between the partners and the partnership.
9. Methods Used Prior to Issuance of Final Regulations
A commentator requested that, for cancellation of debt events
occurring prior to the issuance of final regulations, taxpayers be
allowed to use any reasonable method that conforms with existing
regulations or the proposed regulations in determining which properties
are subject to the basis adjustments under sections 108 and 1017. This
suggestion to provide for retroactive application of these regulations
has not been adopted.
Special Analyses
It has been determined that this final regulation is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It has been determined that a
final regulatory flexibility analysis is required for the collection of
information in this Treasury decision under 5 U.S.C. 604. A summary of
the analysis is set forth below under the heading ``Summary of Final
Regulatory Flexibility Act Analysis.'' Pursuant to section 7805(f) of
the Internal Revenue Code, this final regulation has been submitted to
the Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.
Summary of Final Regulatory Flexibility Act Analysis
This analysis is required under the Regulatory Flexibility Act (5
U.S.C. chapter 6). In certain circumstances, the final regulations will
require a partnership to include a statement with its Form 1065, U.S.
Partnership Return of Income, for the taxable year following the year
that ends with or within the taxable year the taxpayer excludes COD
income from gross income, and provide a statement to the taxpayer on or
before the due date of the requesting partner's return (including
extensions) for the taxable year in which the COD income is excluded
under section 108(a), stating the amount of the partner's share of the
reduction in the partnership's adjusted bases of depreciable real or
personal property (inside basis). This requirement will ensure that the
partner knows it is entitled to reduce the adjusted basis of the
partnership interest and that the affected partnership knows it must
reduce the partner's interest in inside basis. The legal basis for this
requirement is contained in sections 1017(b), 6001, and 7805(a).
Though the final regulations might affect any partnership owning
depreciable property, the IRS and Treasury Department believe that
partnerships owning depreciable real property are the most likely to be
affected. Approximately 1,560,000 partnership returns were filed for
1993. Approximately 620,000 of these were for partnerships owning real
property. It is unlikely, however, that many of these partnerships or
partners in these partnerships will have COD income in any given year,
so it is anticipated that only a small number of these partnerships
will be affected by the final regulations in a particular year.
After a partner conveys information concerning the amount of COD
income excluded from gross income under section 108(a) to the affected
partnership, the partnership must reduce the partner's interest in
inside basis. Accordingly, the partnership must prepare and maintain
special entries on its books because this basis reduction will reduce
the partner's share of the partnership's depreciation deductions, and
ultimate gain or loss on the sale of the property, in subsequent years.
In many cases, partnership returns are prepared using computer software
that can prepare and maintain these special entries after the initial
year.
The IRS and Treasury Department are not aware of any federal rules
that may duplicate, overlap, or conflict with the rule in the final
regulation.
As an alternative to the disclosure described above, the IRS and
Treasury Department considered, but rejected as too burdensome, a rule
that would have required an affected partnership to disclose the
reductions of adjusted basis on a property-by-property basis. There are
no known alternative rules that are less burdensome to small entities
but that accomplish the purpose of the statute.
Drafting Information
The principal authors of these regulations are Sharon L. Hall,
Office of Assistant Chief Counsel (Income Tax and Accounting) and Brian
Blum, Office of Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1, 301 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.108-4 also issued under 26 U.S.C. 108.
Section 1.108-5 also issued under 26 U.S.C. 108. * * *
Section 1.1017-1 also issued under 26 U.S.C. 1017. * * *
Par. 2. Section 1.108-4 is added to read as follows.
Sec. 1.108-4 Election to reduce basis of depreciable property under
section 108(b)(5) of the Internal Revenue Code .
(a) Description. An election under section 108(b)(5) is available
whenever a taxpayer excludes discharge of indebtedness income (COD
income) from gross income under sections 108(a)(1)(A), (B), or (C)
(concerning title 11 cases, insolvency, and qualified farm
indebtedness, respectively). See sections 108(d)(2) and (3) for the
definitions of title 11 case and insolvent. See section 108(g)(2) for
the definition of qualified farm indebtedness.
(b) Time and manner. To make an election under section 108(b)(5), a
taxpayer must enter the appropriate information on Form 982, Reduction
of Tax Attributes Due to Discharge of Indebtedness (and Section 1082
Basis Adjustment), and attach the form to the timely filed (including
extensions) Federal income tax return for the taxable year in which the
taxpayer has COD income that is excluded from gross income under
section 108(a). An election under this section may be
[[Page 56563]]
revoked only with the consent of the Commissioner.
(c) Effective date. This section applies to elections concerning
discharges of indebtedness occurring on or after October 22, 1998.
Sec. 1.108(c)-1 [Redesignated as Sec. 1.108-5]
Par. 3. Section 1.108(c)-1 is redesignated as Sec. 1.108-5.
Par. 4. Section 1.108-6 is added to read as follows:
Sec. 1.108-6 Limitations on the exclusion of income from the discharge
of qualified real property business indebtedness.
(a) Indebtedness in excess of value. With respect to any qualified
real property business indebtedness that is discharged, the amount
excluded from gross income under section 108(a)(1)(D) (concerning
discharges of qualified real property business indebtedness) shall not
exceed the excess, if any, of the outstanding principal amount of that
indebtedness immediately before the discharge over the net fair market
value of the qualifying real property, as defined in Sec. 1.1017-
1(c)(1), immediately before the discharge. For purposes of this
section, net fair market value means the fair market value of the
qualifying real property (notwithstanding section 7701(g)), reduced by
the outstanding principal amount of any qualified real property
business indebtedness (other than the discharged indebtedness) that is
secured by such property immediately before and after the discharge.
Also, for purposes of section 108(c)(2)(A) and this section,
outstanding principal amount means the principal amount of indebtedness
together with all additional amounts owed that, immediately before the
discharge, are equivalent to principal, in that interest on such
amounts would accrue and compound in the future, except that
outstanding principal amount shall not include amounts that are subject
to section 108(e)(2) and shall be adjusted to account for unamortized
premium and discount consistent with section 108(e)(3).
(b) Overall limitation. The amount excluded from gross income under
section 108(a)(1)(D) shall not exceed the aggregate adjusted bases of
all depreciable real property held by the taxpayer immediately before
the discharge (other than depreciable real property acquired in
contemplation of the discharge) reduced by the sum of any--
(1) Depreciation claimed for the taxable year the taxpayer excluded
discharge of indebtedness from gross income under section 108(a)(1)(D);
and
(2) Reductions to the adjusted bases of depreciable real property
required under section 108(b) or section 108(g) for the same taxable
year.
(c) Effective date. This section applies to discharges of qualified
real property business indebtedness occurring on or after October 22,
1998.
Sec. 1.108(a)-1 [Removed]
Par. 5. Section 1.108(a)-1 is removed.
Sec. 1.108(a)-2 [Removed]
Par. 6. Section 108(a)-2 is removed.
Sec. 1.108(b)-1 [Removed]
Par. 7. Section 1.108-(b)-1 is removed.
Sec. 1.1016-7 [Removed]
Par. 8. Section 1.1016-7 is removed.
Sec. 1.1016-8 [Removed]
Par. 9. Section 1.1016-8 is removed.
Par. 10. Section 1.1017-1 is revised to read as follows:
Sec. 1.1017-1 Basis reductions following a discharge of indebtedness.
(a) General rule for section 108(b)(2)(E). This paragraph (a)
applies to basis reductions under section 108(b)(2)(E) that are
required by section 108(a)(1) (A) or (B) because the taxpayer excluded
discharge of indebtedness (COD income) from gross income. A taxpayer
must reduce in the following order, to the extent of the excluded COD
income (but not below zero), the adjusted bases of property held on the
first day of the taxable year following the taxable year that the
taxpayer excluded COD income from gross income (in proportion to
adjusted basis):--
(1) Real property used in a trade or business or held for
investment, other than real property described in section 1221(1), that
secured the discharged indebtedness immediately before the discharge;
(2) Personal property used in a trade or business or held for
investment, other than inventory, accounts receivable, and notes
receivable, that secured the discharged indebtedness immediately before
the discharge;
(3) Remaining property used in a trade or business or held for
investment, other than inventory, accounts receivable, notes
receivable, and real property described in section 1221(1);
(4) Inventory, accounts receivable, notes receivable, and real
property described in section 1221(1); and
(5) Property not used in a trade or business nor held for
investment.
(b) Operating rules--(1) Prior tax-attribute reduction. The amount
of excluded COD income applied to reduce basis does not include any COD
income applied to reduce tax attributes under sections 108(b)(2)(A)
through (D) and, if applicable, section 108(b)(5). For example, if a
taxpayer excludes $100 of COD income from gross income under section
108(a) and reduces tax attributes by $40 under sections 108(b)(2)(A)
through (D), the taxpayer is required to reduce the adjusted bases of
property by $60 ($100--$40) under section 108(b)(2)(E).
(2) Multiple discharged indebtednesses. If a taxpayer has COD
income attributable to more than one discharged indebtedness resulting
in the reduction of tax attributes under sections 108(b)(2)(A) through
(D) and, if applicable, section 108(b)(5), paragraph (b)(1) of this
section must be applied by allocating the tax-attribute reductions
among the indebtednesses in proportion to the amount of COD income
attributable to each discharged indebtedness. For example, if a
taxpayer excludes $20 of COD income attributable to secured
indebtedness A and excludes $80 of COD income attributable to unsecured
indebtedness B (a total exclusion of $100), and if the taxpayer reduces
tax attributes by $40 under sections 108(b)(2)(A) through (D), the
taxpayer must reduce the amount of COD income attributable to secured
indebtedness A to $12 ($20--($20 / $100 x $40)) and must reduce the
amount of COD income attributable to unsecured indebtedness B to $48
($80--($80 / $100 x $40)).
(3) Limitation on basis reductions under section 108(b)(2)(E) in
bankruptcy or insolvency. If COD income arises from a discharge of
indebtedness in a title 11 case or while the taxpayer is insolvent, the
amount of any basis reduction under section 108(b)(2)(E) shall not
exceed the excess of--
(i) The aggregate of the adjusted bases of property and the amount
of money held by the taxpayer immediately after the discharge; over
(ii) The aggregate of the liabilities of the taxpayer immediately
after the discharge.
(c) Modification of ordering rules for basis reductions under
sections 108(b)(5) and 108(c)--(1) In general. The ordering rules
prescribed in paragraph (a) of this section apply, with appropriate
modifications, to basis reductions under sections 108(b)(5) and (c).
Thus, a taxpayer that elects to reduce basis under section 108(b)(5)
may, to the extent that the election applies, reduce only the adjusted
basis of property described in paragraphs (a)(1), (2), and (3) of this
section and, if an election is made under paragraph (f) of this
section, paragraph (a) (4) of this
[[Page 56564]]
section. Within paragraphs (a)(1), (2), (3) and (4) of this section,
such a taxpayer may reduce only the adjusted bases of depreciable
property. A taxpayer that elects to apply section 108(c) may reduce
only the adjusted basis of property described in paragraphs (a)(1) and
(3) of this section and, within paragraphs (a)(1) and (3) of this
section, may reduce only the adjusted bases of depreciable real
property. Furthermore, for basis reductions under section 108(c), a
taxpayer must reduce the adjusted basis of the qualifying real property
to the extent of the discharged qualified real property business
indebtedness before reducing the adjusted bases of other depreciable
real property. The term qualifying real property means real property
with respect to which the indebtedness is qualified real property
business indebtedness within the meaning of section 108(c)(3). See
paragraphs (f) and (g) of this section for elections relating to
section 1221(1) property and partnership interests.
(2) Partial basis reductions under section 108(b)(5). If the amount
of basis reductions under section 108(b)(5) is less than the amount of
the COD income excluded from gross income under section 108(a), the
taxpayer must reduce the balance of its tax attributes, including any
remaining adjusted bases of depreciable and other property, by
following the ordering rules under section 108(b)(2). For example, if a
taxpayer excludes $100 of COD income from gross income under section
108(a) and elects to reduce the adjusted bases of depreciable property
by $10 under section 108(b)(5), the taxpayer must reduce its remaining
tax attributes by $90, starting with net operating losses under section
108(b)(2).
(3) Modification of fresh start rule for prior basis reductions
under section 108(b)(5). After reducing the adjusted bases of
depreciable property under section 108(b)(5), a taxpayer must compute
the limitation on basis reductions under section 1017(b)(2) using the
aggregate of the remaining adjusted bases of property. For example, if,
immediately after the discharge of indebtedness in a title 11 case, a
taxpayer's adjusted bases of property is $100 and its undischarged
indebtedness is $70, and if the taxpayer elects to reduce the adjusted
bases of depreciable property by $10 under section 108(b)(5), section
1017(b)(2) limits any further basis reductions under section
108(b)(2)(E) to $20 (($100-$10)-$70).
(d) Changes in security. If any property is added or eliminated as
security for an indebtedness during the one-year period preceding the
discharge of that indebtedness, such addition or elimination shall be
disregarded where a principal purpose of the change is to affect the
taxpayer's basis reductions under section 1017.
(e) Depreciable property. For purposes of this section, the term
depreciable property means any property of a character subject to the
allowance for depreciation or amortization, but only if the basis
reduction would reduce the amount of depreciation or amortization which
otherwise would be allowable for the period immediately following such
reduction. Thus, for example, a lessor cannot reduce the basis of
leased property where the lessee's obligation in respect of the
property will restore to the lessor the loss due to depreciation during
the term of the lease, since the lessor cannot take depreciation in
respect of such property.
(f) Election to treat section 1221(1) real property as
depreciable--(1) In general. For basis reductions under section
108(b)(5) and basis reductions relating to qualified farm indebtedness,
a taxpayer may elect under sections 1017(b)(3)(E) and (4)(C),
respectively, to treat real property described in section 1221(1) as
depreciable property. This election is not available, however, for
basis reductions under section 108(c).
(2) Time and manner. To make an election under section
1017(b)(3)(E) or (4)(C), a taxpayer must enter the appropriate
information on Form 982, Reduction of Tax Attributes Due to Discharge
of Indebtedness (and Section 1082 Basis Adjustment), and attach the
form to a timely filed (including extensions) Federal income tax return
for the taxable year in which the taxpayer has COD income that is
excluded from gross income under section 108(a). An election under this
paragraph (f) may be revoked only with the consent of the Commissioner.
(g) Partnerships--(1) Partnership COD income. For purposes of
paragraph (a) of this section, a taxpayer must treat a distributive
share of a partnership's COD income as attributable to a discharged
indebtedness secured by the taxpayer's interest in that partnership.
(2) Partnership interest treated as depreciable property--(i) In
general. For purposes of making basis reductions, if a taxpayer makes
an election under section 108(b)(5) (or 108(c)), the taxpayer must
treat a partnership interest as depreciable property (or depreciable
real property) to the extent of the partner's proportionate share of
the partnership's basis in depreciable property (or depreciable real
property), provided that the partnership consents to a corresponding
reduction in the partnership's basis (inside basis) in depreciable
property (or depreciable real property) with respect to such partner.
(ii) Request by partner and consent of partnership--(A) In general.
Except as otherwise provided in this paragraph (g)(2)(ii), a taxpayer
may choose whether or not to request that a partnership reduce the
inside basis of its depreciable property (or depreciable real property)
with respect to the taxpayer, and the partnership may grant or withhold
such consent, in its sole discretion. A request by the taxpayer must be
made before the due date (including extensions) for filing the
taxpayer's Federal income tax return for the taxable year in which the
taxpayer has COD income that is excluded from gross income under
section 108(a).
(B) Request for consent required. A taxpayer must request a
partnership's consent to reduce inside basis if, at the time of the
discharge, the taxpayer owns (directly or indirectly) a greater than 50
percent interest in the capital and profits of the partnership, or if
reductions to the basis of the taxpayer's depreciable property (or
depreciable real property) are being made with respect to the
taxpayer's distributive share of COD income of the partnership.
(C) Granting of request required. A partnership must consent to
reduce its partners' shares of inside basis with respect to a
discharged indebtedness if consent is requested with respect to that
indebtedness by partners owning (directly or indirectly) an aggregate
of more than 80 percent of the capital and profits interests of the
partnership or five or fewer partners owning (directly or indirectly)
an aggregate of more than 50 percent of the capital and profits
interests of the partnership. For example, if there is a cancellation
of partnership indebtedness that is secured by real property used in a
partnership's trade or business, and if partners owning (in the
aggregate) 90 percent of the capital and profits interests of the
partnership elect to exclude the COD income under section 108(c), the
partnership must make the appropriate reductions in those partners'
shares of inside basis.
(iii) Partnership consent statement--(A) Partnership requirement. A
consenting partnership must include with the Form 1065, U.S.
Partnership Return of Income, for the taxable year following the year
that ends with or within the taxable year the taxpayer excludes COD
income from gross income under section 108(a), and must provide to the
taxpayer on or before the due date of the taxpayer's return (including
extensions) for the taxable year in which the taxpayer excludes
[[Page 56565]]
COD income from gross income, a statement that--
(1) Contains the name, address, and taxpayer identification number
of the partnership; and
(2) States the amount of the reduction of the partner's
proportionate interest in the adjusted bases of the partnership's
depreciable property or depreciable real property, whichever is
applicable.
(B) Taxpayer's requirement. Statements described in paragraph
(g)(2)(iii)(A) of this section must be attached to a taxpayer's timely
filed (including extensions) Federal income tax return for the taxable
year in which the taxpayer has COD income that is excluded from gross
income under section 108(a).
(iv) Partner's share of partnership's adjusted basis. [Reserved]
(3) Partnership basis reduction. The rules of this section
(including this paragraph (g)) apply in determining the properties to
which the partnership's basis reductions must be made.
(h) Special allocation rule for cases to which section 1398
applies. If a bankruptcy estate and a taxpayer to whom section 1398
applies (concerning only individuals under Chapter 7 or 11 of title 11
of the United States Code) hold property subject to basis reduction
under section 108(b)(2)(E) or (5) on the first day of the taxable year
following the taxable year of discharge, the bankruptcy estate must
reduce all of the adjusted bases of its property before the taxpayer is
required to reduce any adjusted bases of property.
(i) Effective date. This section applies to discharges of
indebtedness occurring on or after October 22, 1998.
Sec. 1.1017-2 [Removed]
Par. 11. Section 1.1017-2 is removed.
PART 301--PROCEDURE AND ADMINISTRATION
Par. 12. The authority citation for part 301 continues to read as
follows:
Authority: 26 U.S.C. 7805 * * *
Sec. 301.9100-13T [Removed]
Par. 13. Section 301.9100-13T is removed.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 14. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 15. Section 602.101(c) is amended by:
1. Adding the following entries in numerical order to the table:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control
No.
------------------------------------------------------------------------
* * * * *
1.108-4.................................................... 1545-1539
1.108-5.................................................... 1545-1421
* * * * *
1.1017-1................................................... 1545-1539
* * * * *
------------------------------------------------------------------------
2. Removing the following entries in numerical order from the
table:
* * * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control
No.
------------------------------------------------------------------------
* * * * *
1.108(a)-1................................................. 1545-0046
1.108(a)-2................................................. 1545-0046
1.108(c)-1................................................. 1545-1421
* * * * *
1.1017-2................................................... 1545-0028
1545-0046
* * * * *
301.9100-13T............................................... 1545-0046
------------------------------------------------------------------------
Approved: September 14, 1998.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 98-28263 Filed 10-21-98; 8:45 am]
BILLING CODE 4830-01-U
