An update to the COD provisions amended by the RRA.

• Author: Grooms, William M.
• Position: Cancellation of indebtedness

The Revenue Reconciliation Act of 1993 (RRA) has brought about many changes to the Internal Revenue Code. These changes are pervasive, affecting almost every area of taxation. One of the items that did not go unscathed is Sec. 108, which deals with income resulting from the cancellation of debt (COD).

Sec. 108 recognizes that gross income would normally include any income arising as a result of COD. Given this general operating rule, Sec. 108(a)(1) them provides an exception.

Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer. ...

Under pre-RRA law, Sec. 108(a)(1) sets fort three conditions in which COD does not result in income.

1. If the discharge occurs as a result of a Title 11 (bankruptcy or similar proceedings) case;

2. The discharge occurs when the taxpayers are insolvent; or

3. The indebtedness discharged is qualified farm indebtedness. (All of these terms are further defined within Sec. 108.)

The RRA added a fourth exception, which occurs when, "in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness." (Sec. 108(a)(1)(D).)

Obviously, these words all have special meanings when they are used in such a context. Whenever the term "qualified" precedes the term "real property business indebtedness," this does not mean just any "real property business indebtedness." Accordingly, the term "qualified" must be defined.

New Sec. 108(c) is appropriately entitled "Treatment of discharge of qualified real property business indebtedness." The new subsection defines qualified real property business indebtedness as indebtedness 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. (Sec. 108(c)(3.).)

Note: Farm indebtedness is dealt with separately in Sec. 108(a)(1)(C) as it stood before modification by the RRA.

It is obvious that real property business indebtedness is qualified if there was a mortgage on the property incurred or assumed by the taxpayer before Jan. 1, 1993. The indebtedness will still be qualified if...