Capital gain results when secured property is sold and proceeds are assigned to creditor in satisfaction of debt.

• Author: Mortenson, Paul

Briarpark Ltd., TC Memo 1997-298, illustrates how a taxpayer may be able to control the taxation of the sale of a secured asset and the assignment of the proceeds to the secured creditor, coupled with a related forgiveness of the nonrecourse debt. Briarpark provides an opportunity to get desired treatment with proper structuring but also creates uncertainty as to how far a court will go in treating two transactions as one.

Typically, a bank does not want to own the property securing a nonrecourse, nonperforming loan that has declined in value. Instead, the bank will request (or require) that the debtor sell the property and assign the sales proceeds to the bank. In return, the bank will release its interest in the property securing the loan.

Example: D owns Blackacre in which it has a $50 basis; its fair market value (FMV) is $20. D owes Bank $100 (a nonrecourse note), secured by Blackacre. D and Bank both want to retire the debt, but the Bank does not want Blackacre. The Bank agrees to release its security interest and forgive the remaining debt when D finds a buyer and assigns the proceeds to the Bank.

Generally, taxpayers have treated this as two separate transactions. First, the sale to a buyer for $20 would result in a $30 capital loss ($50 basis-$20 received). Second, the assignment of the $20 sales proceeds in satisfaction of the $100 note would be treated as $80 of discharge of indebtedness income (DOI), pursuant to Sec. 61(a)(12) (see, e.g., Liberty Mirror Works, 3 TC 1018 (1944)). If, instead, D merely deeded the property to the bank in lieu of a foreclosure, a disposition would occur resulting in a $50 capital gain ($100 received -- $50 basis); see Tufts, 461 US 300 (1983), holding that the amount realized on the disposition of real property subject to a nonrecourse debt included the full amount of the note assumed by the purchaser, even though the note exceeded the property's fair market value. See also Regs. Sec. 1.1001-2(a), which provides that the amount realized from a sale of property includes the liabilities from which the transferor is discharged as a result of the sale.

Briarpark involved a transaction similar to the example. A bank agreed to discharge a nonrecourse loan secured by property only if it were sold and the proceeds of the sale were assigned to it. Specifically, the bank required a minimum sales price, assignment of the proceeds to it, the transfer of Briarpark's cash reserves and a cash payment by one of...