An exclusion of income from a discharge of qualified real property business indebtedness (QRPBI) under Sec. 108(a)(1)(D) is available to taxpayers that are not C corporations. The exclusion does not apply to a discharge that takes place in a Title 11 bankruptcy case and not to the extent the taxpayer is insolvent. Recently issued Chief Counsel Advice (CCA) 201623009 clarifies some of the rules regarding the limitations on the amount of the exclusion imposed by Sec. 108(c)(2).
According to Sec. 108(c)(3), QRPBI is debt that:
(A) was incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property,
(B) was incurred or assumed before January 1, 1993, or if incurred or assumed on or after such date, is qualified acquisition indebtedness, and
(C) with respect to which such taxpayer makes an election to have this paragraph apply.
The term "qualified acquisition indebtedness" means indebtedness incurred or assumed to acquire, construct, reconstruct, or substantially improve the property.
CCA 201623009 discusses two interpretations of the meaning of real property under Sec. 108(c)(3). Under one interpretation, real property refers to all real property held by a taxpayer that has some debt that is QRPBI. When there are two items of real property, each with its own debt, the fair market value (FMV) of both properties would be considered in determining the QRPBI exclusion.
Under a second interpretation, real property relates to the sole item of real property that had debt discharged that is QRPBI. When a taxpayer holds two items of real property, each with its own debt, the FMV of only the property with the discharged debt that is QRPBI would be taken into consideration for the QRPBI exclusion. The CCA states that the second interpretation that property refers to one and only one item is the correct interpretation.
In clarifying this matter, CCA 201623009 states that "the term 'qualified real property business indebtedness' . . . refers only to debts that are QRPBI with respect to the same item of real property" in Sec. 108(c)(3)(A). The CCA gives the following example:
The Taxpayer owns two items of real property used in a trade or business, Property A and Property B. At the time of the debt forgiveness at issue, Property A had a fair market value of $a and was security on Debt C with a principal amount of $b. At the same time, Property B had a fair market value of $c and was security on Debt D with a principal amount of $d. Debt D was also secured by Property A, and Debt C was secured by Property B. The proceeds from Debt C were used to improve Property A and were not used for Property B. The proceeds from Debt D were used to construct or improve Property B and not used for Property A.
Debt C was reduced to $e, reflecting a discharge amount.
In analyzing the facts, the Chief Counsel's Office concluded:
[T]he proceeds of Debt C were used to improve Property A and were not used for Property B. Consequently, Debt C is qualified acquisition indebtedness (within the meaning of section 108(c)(4)) only for Property A and not Property B. Thus, Debt C is QRPBI only with respect to Property A. Similarly, the proceeds of Debt D were used to construct or improve Property B and were not used for Property A. Debt D is qualified acquisition indebtedness only for Property B, and thus is QRPBI only with respect to Property B and not Property A.
The only QRPBI with respect to Property A is Debt C. Because Debt C is the debt discharged, the fair market value of Property A is not reduced by any amount under the formula for the fair market value in [Regs. Sec] 1.108-6(a). Under the QRPBI exclusion limitation, the Taxpayer may exclude no more than the amount by which the principal amount of Debt C ($b) exceeds the net fair market value of Property A ($a). Consequently, the Taxpayer may exclude [some] of the amount of Debt C that was discharged.
This example indicates that the calculation refers to a single item of real property for which the discharged debt is QRPBI.
Mark Cook is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or email@example.com.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.