New exclusion for income from discharge of real property business debt: partners v. partnership.

• Author: Dudzinsky, Robert J.

Under new Sec. 108(a)(1)(D) and (c), for a non-C corporation payer, income from post- 1992 discharge of qualified real property business indebtedness" (QRPBI) is excluded from gross income subject to limitations. Under Sec. 108(c)(3), QRPBI must be - incurred or assumed by the taxpayer in connection with real property used in a trade or business and be secured by that property, and - incurred or assumed before 1993 or, if incurred or assumed after 1992, "qualified acquisition indebtedness."

Qualified acquisition indebtedness must be incurred or assumed to acquire, construct, reconstruct or substantially improve real property used in a trade or business and must be secured by that property (Sec. 108(c)(4)).

Sec. 108(c)(3)(C) also requires the taxpayer to elect the application of Sec. 108(c)(3) to debt that would otherwise qualify as QRPBI. Under Ann. 94-11, this election must be made by checking a new box on the December 1993 revision of Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment). The January 1995 revision of this form must be used for debt discharges in tax years beginning after 1993.

If QRPBI is refinanced, the new debt will be QRPBI only to the extent it does not exceed the QRPBI being refinanced. (See House Report, at 185, on the Revenue Reconciliation Act of 1993.)

The existing gross income exclusions for debt discharges occurring in a Title 1 1 case or when a taxpayer is insolvent take priority over this new QRPBI exclusion (Sec. 108(a)(2)). However, under Sec. 108(d)(6), the exclusion of income from the discharge of QRPBI is applied at the partner level (on a partner-by-partner basis) and not at the partnership level. Therefore, a partner's solvency status (instead of the partnership's) is relevant. Accordingly, a partnership's insolvency will not preclude a solvent partner from using these new QRPBI rules.

The Sec. 108(c)(3)(C) election must be made on the taxpayer's return for the tax year in which the discharge occurs (or at such other time as permitted by regulations) (Sec. 108(d)(9)).

Under Sec. 108(c)(2), the amount of QRPBI discharge income that may be excluded from gross income under Sec. 108(a)(1)(D) cannot exceed the excess of - the debt's outstanding principal amount, over - the fair market value (FMV) of the real property securing that debt, reduced by the outstanding principal amount of any other QRPBI secured by such property. This excess is measured...