INSIGHTS AND RESOURCES

Tax Court clarifies timing of basis reduction following COD event

TAX ALERT  | 

Authored by RSM US LLP


In Hussey v. Comm’r, 156 T. C. 12, filed on June 24, 2021, the Tax Court held a taxpayer was required to reduce his aggregate bases in depreciable real properties in the same year he received a discharge of qualified real property business indebtedness and sold the property.  

Hussey illustrates that when a taxpayer must reduce tax attributes under sections 108 and 1017, the taxpayer must take care to reduce the basis in the appropriate year.

Statutory Background

Although a taxpayer does not realize gross income upon the receipt of loan proceeds, a taxpayer does generally realize gross income when a debt is forgiven, under section 61(a)(11). There are, however, a number of exceptions to the general rule of income inclusion upon debt discharge, contained in section 108. Some well-known exceptions relate to a taxpayer that is insolvent or bankrupt. A lesser known exception is found in section 108(a)(1)(D), which generally excludes from income the forgiveness of qualified real property business indebtedness (“QRPBI”), which refers to debt incurred to acquire, construct, or improve real property. Where the exclusion applies, the taxpayer must reduce their basis in the depreciable real property, under section 108(c)(1)(A). Thus, this provision generally results in income deferral rather than income exclusion.

The rules for this reduction of basis are found in section 108(c)(1)(B), which references section 1017. The general rule of section 1017(a) states that the reduction of the basis of property occurs at the beginning of the taxable year following the year of discharge. Section 1017(b)(3)(F)(iii), however, provides that in the case of property taken into account under section 108(c)(2)(B), which relates to the QRPBI exclusion, the reduction must be made immediately before the disposition of the property (if earlier than the beginning of the next taxable year). 

Section 108(c)(2)(B) generally provides that the amount of discharged QRPBI excluded from a taxpayer's income may not exceed the aggregate bases of the taxpayer's depreciable real properties held immediately before the discharge.

Hussey v. Comm’r 

Mr. Hussey sold investment properties in 2012, and his mortgage lender forgave the debt relating to most of those properties. Hussey then sold additional investment properties in 2013. The pivotal question in the case was whether Hussey was required to reduce his bases in his properties in 2012 – the year of discharge, or in 2013 – the year following the discharge. The answer to this question affected Hussey’s basis in the properties he sold in 2013, and the resulting gain/loss on those sales. 

The Tax Court reasoned that since Hussey received a discharge of QRPBI and sold properties in 2012, he was required to reduce his bases in the disposed properties immediately before the sales of those properties in 2012. Hussey had argued before the court that since the aggregated bases in his unsold properties in 2012 exceeded the discharged amount, he did not need to reduce his bases until the following year. Based on the text of the statute and legislative history, the court rejected this argument, noting that selling properties from that group triggers section 1017(b)(3)(F)(iii) with respect to the bases of the properties sold regardless of the remaining bases in the properties not sold. 

Through this case, the Tax Court provided clarity around the timing of the basis reduction where debt forgiveness of QRPBI is followed by sales of those properties.

Takeaway 

Hussey illustrates that when a taxpayer must reduce its tax basis under sections 108 and 1017, the taxpayer must take care to reduce the basis in the appropriate year. While the general rule of section 1017 requires a basis reduction in the year following the debt discharge, taxpayers should be cautious of the special rules for discharge of QRPBI.  

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This article was written by Patrick Phillips, Joseph Wiener, Nate Meyers and originally appeared on 2021-06-25.
2021 RSM US LLP. All rights reserved.
https://rsmus.com/what-we-do/services/tax/federal-tax/tax-mergers-and-acquisitions/tax-court-clarifies-timing-of-basis-reduction-following-cod-even.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

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