Recognition of COD income realized on satisfaction of debt with partnership interest.
Under AJCA Section 896, when a partnership transfers a capital or profits interest in the partnership to a creditor in satisfaction of partnership debt, the partnership generally recognizes COD income in the amount that would be recognized if the debt were satisfied with money equal to the FMV of the partnership interest. The provision applies without regard to whether the cancelled debt is recourse or nonrecourse. Further, any COD income so recognized is allocated to the partners who held interests in the partnership immediately before satisfaction of the debt.
This provision is effective for CODs occurring after Oct. 21, 2004. Committee Reports indicate that no inference is intended as to the treatment of such transactions under present law.
This change is likely to cause severe adverse tax consequences in many real estate debt "workouts." COD income may exist regardless of the solvency of the partnership, as the test focuses on the value of the equity provided. One example of a solvent partnership falling under this rule could be a situation in which the FMV of the equity interest exchanged is less than the face amount of the debt, due to a change in market interest rates as compared to the interest rate used by the debt instrument. This rule only applies to COD income as it relates to the partnership and does not address the consequences to the creditor. Thus, it is possible that the creditor's loss may be capitalized into the basis of the partnership interest that it receives.
FROM STEVEN SCHNEIDER AND ROBERT CRNKOVICH, WASHINGTON, DC
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|Title Annotation:||cancellation of debt|
|Publication:||The Tax Adviser|
|Date:||Jan 1, 2005|
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