Consider disposing of depreciable real property or making a sec. 108(c)(3)(C) election in the same year that debt is discharged.
Generally, under Sec. 61 (a) (12), gross income means all income from whatever source derived, including income from discharge of indebtedness. Consequently, unless a statutory exclusion applies, discharge of indebtedness income is recognized on the cancellation, reduction or forgiveness of debt and/or the transfer of encumbered Encumbered
A property owned by one party on which a second party reserves the right to make a valid claim, e.g., a bank's holding of a home mortgage encumbers property. property (see, e.g., Kirby Lumber Co., 284 US 1 (1931)). Typically, the amount of discharge of indebtedness income equals the amount of debt discharged less the amount paid by the debtor to the creditor.
However, when encumbered property is transferred in a foreclosure foreclosure
Legal proceeding by which a borrower's rights to a mortgaged property may be extinguished if the borrower fails to live up to the obligations agreed to in the loan contract. or in lieu of foreclosure, the recognition of discharge of indebtedness income depends on whether the debt is recourse or nonrecourse. Under Regs. Sec. 1.1001-2(a), relief from indebtedness resulting from the transfer of property encumbered by nonrecourse debt A nonrecourse debt or non-recourse debt or nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. is deemed derived from the disposition of such property. Therefore, the gain is treated as part of the amount realized “Amount Realized” is one of two variables in the formula used to compute gains and losses when determining gross income for tax purposes. The Amount Realized – Adjusted Basis tells the amount of Realized Gain (if positive) or Realized Loss (if negative). from the sale or exchange of the property and no discharge of indebtedness income results. Alternatively, under Regs. Sec. 1.1001-2(c), Example 8, and Danenberg, 73 TC 370 (1979), relief from indebtedness resulting from the transfer of property encumbered by recourse debt may be both discharge of indebtedness income and gain derived from the disposition of the property. The regulations appear to bifurcate To divide into two. the transaction, and provide that gain from the sale or exchange of property arises to the extent that the property's fair market value (FMV FMV - full-motion video ) exceeds its basis and debt discharge income arises to the extent of the excess of the debt over the FMV.
Under Sec. 108(a), amounts includible in gross income resulting from discharge of indebtedness income may be excluded when the discharge occurs in a bankruptcy proceeding, while the debtor is insolvent INSOLVENT. This word has several meanings. It signifies a person whose estate is not sufficient to pay his debts. Civ. Code of Louisiana, art. 1980.. A person is also said to be insolvent, who is under a present inability to answer, in the ordinary course of business, the responsibility , if the debt is qualified farm indebtedness, or if the debt is qualified real property business indebtedness and an election under Sec. 108(c) (3) (C) is made by a non-C corporation tax-payer. Hence, if debt is relived through the transfer of nonrecourse encumbered property, it appears that the Sec. 108(a) exclusions are inapplicable in·ap·pli·ca·ble
Not applicable: rules inapplicable to day students.
As a general rule, if debt forgiveness income is excluded, a reduction of specified tax attributes is required under Sec. 108(b) for Sec. 108(a) (1) (A), (B) or (C) exclusions, and pursuant to Sec. 108(c) (1) for Sec. 108(a) (1) (D) exclusions. Under Sec. 1017(a), the amount excluded from gross income under Sec. 108(a), which is applied to reduce basis pursuant to Sec. 108(b) (2) (D) [sic] (E), (b) (5), or (c) (1), is applied to reduce the basis of property held by the taxpayer at the beginning of the tax year following the tax year in which the discharge occurs. Accordingly, if the discharge is excluded from income under Sec. 108(a) (1) (A) or (B), when the taxpayer is bankrupt or insolvent, and no other Sec. 108(b) (2) attributes exist, to the extent the taxpayer converts the property into money or disposes of the property before the next tax year, no attribute reduction results and a permanent exclusion from gross income is obtained.
However, if relief is only available and elected under Sec. 108(c) (3) (C), and the taxpayer disposes of depreciable depreciable
Of, relating to, or being a long-term tangible asset that is subject to depreciation. real property (see Sec. 108(c) (2) (B) either in a transaction giving rise to the discharge or otherwise, before the first day of the next tax year, Sec. 1017(b) (3) (F) requires a reduction in the basis of such property immediately before its disposition. Therefore, if the taxpayer is neither bankrupt nor insolvent, electing the Sec. 108(a) (1) (D) exclusion reduces the property's basis. As a result, what would otherwise be ordinary income produces capital gain.
(See also Tax Clinic, "New Exclusion for Income From Discharge of Real Property Business Debt: Partners vs. Partnership," TTA TTA Telecommunications Technology Association (Korea)
TTA Teacher Training Agency (UK)
TTA Triangle Transit Authority (Raleigh/Chapel Hill/Durham, North Carolina, USA) , May 1994, p. 289.)