IRS finalizes regs. on basis reduction on excluded DOI income.

• Author: Sair, Edward A.
• Position: Discharge of indebtedness IRS regulations

On Oct. 21, 1998, the IRS finalized regulations originally issued in January 1997 on reduction of tax basis of property due to discharge of indebtedness (DOI) income. The regulations cover basis reductions when DOI is excluded because of the debtor's bankruptcy or insolvency or when the debt is qualified farm indebtedness. The regulations also cover the election to reduce the basis of depreciable property in lieu of other tax attributes and the election to reduce the basis of depreciable real property when qualified real property business indebtedness (QRPBI) is discharged.

Overview

In general, Sec. 108(a) excludes from gross income any DOI income when the discharge occurs in either a tide 11 case (bankruptcy), the taxpayer is insolvent or the indebtedness is "qualified farm indebtedness" or (if so elected) "qualified real property business indebtedness." Under Sec. 108(b), taxpayers generally must reduce specified tax attributes, including adjusted bases of properties, to the extent DOI income is excluded from gross income. Sec. 108(b)(2) requires a taxpayer to reduce tax attributes in the following order: (1) net operating loss; (2) general business credit; (3) minimum tax credit; (4) capital loss carryovers; (5) adjusted bases of property; (6) passive activity loss and credit carryovers; and (7) foreign tax credit carryovers.

In lieu of the order of attribute reduction specified by Sec. 108(b)(2), a taxpayer may elect under Sec. 108(b)(5) to first reduce the adjusted basis of depreciable property (real and personal) to the extent of the excluded DOI income. If the debt is QRPBI and the debtor is neither in bankruptcy nor insolvent, an election may be made to exclude DOI income and reduce depreciable basis in real property; see Sec. 108(a)(1)(D) and (c).

Sec. 1017 provides rules for the basis reductions required by or elected under Sec. 108. When basis reductions are necessary, Sec. 1017(a) requires the taxpayer to reduce the adjusted bases of property held on the first day of the following tax year. Sec. 1017(b)(1) provides that the amount of the basis reduction required under Sec. 1017(a) and the particular properties the bases of which are to be reduced shall be determined by regulations. Sec. 1017(b)(2) limits the basis reduction for debt discharged in bankruptcy or when the taxpayer is insolvent to the excess of the aggregate adjusted bases of the taxpayer's assets immediately after the discharge over the amount of remaining...