The sec. 108(c) (3) (C) election: clarification and amplification.

• Author: Dudzinsky, Robert J.
• Position: Response to article in Tax Adviser, vol. 27, no. 5, p. 269, May 1996

Under Sec. 108(a) amounts resulting from discharge of indebtedness income may be excluded from gross income resulting from discharge of be excluded from gross income if the debit is qualified real property business indebtedness (QRPBI) and an election under Sec. 108(c)(1)and 1017(a) C corporation taxpayer. However under Secs. 108(c)(1) and 1017(a) when the election is made, the amount of discharged QRPBI excluded from gross income must reduce the basis of depreciable red property held by the taxpayer at the beginning of of the tax year following the tax year m which the debt discharge occurred; see Tax Clinic, "Consider Disposing of Depreciable Real Property or Making a Sec. 108(c)(3)(C) Election in the Same year that Debt is Discharged" TTA May 1996, p 269.

The penultimate paragraph of that prior Tax Clinic item stated:

However, if relief is only available and elected under Sec. 108(c)(3)(C), and them taxpayer disposes of depreciable real property (see Sec. 108(c)(2)(B) either in a giving rise to die discharge or otherwise, before the first day of die next tax year, Sec. 1017(b)(3)(F) requires a reduction in die basis of such property immediately before its disposition. Therefore, if die taxpayer is neither bankrupt nor insolvent, electing the Sec. 108(a)(1)(D) exclusion reduces the property's basis. As a result, what would otherwise be ordinary income produces capital gain.

However, Sec. 1017(d)(1)(B) provides that such basis reductions are treated as depreciation deductions subject to Sec. 1250 recapture. On the other hand, in determining the Sec. 1250(b) limitation (additional depreciation) for such recapture, the straight-line depreciation that would have been allowed is computed as if there had been no basis reduction under Sec. 1017 (see Sec 1017(d)(2). In other words the computation of straight-line depreciation under Sec 1250)b) for property whose basis has been reduced under Sec. 1017 is made as if there has been no basis reduction under Sec, 1017 due to discharge of indebtedness. The House Report to the Revenue Reconciliation Act of 1993 states:

If depreciable real property, the basis of which was reduced under this provision is disposed of, then for purposes of determining the amount of recapture under section 1250: (1) any such basis reduction is treated as a deduction allowed for depreciation, and (2) the determination of what would have been depreciation adjustment under the straight line method is made as if there had been...