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.
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.
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.
Call us at (800) 624-2400 or fill out the form below and we'll contact you to discuss your specific situation.
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.
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.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Weinlander Fitzhugh is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Weinlander Fitzhugh can assist you, please call (989) 893-5577.