Treatment of COD income under secs. 704 and 752.

• Author: Kipper, Richard N.
• Position: Cancellation of debt

Sec. 752(b) distributions

Rev. Rul. 92-97 held that a deemed cash distribution under Sec. 752(b) (through a reduction in a partner's share of a partnership liability), if integrally related to cancellation of debt (COD) income, will be treated as occurring at the end of the partnership tax year in determining whether gain is recognized under Sec. 731(a). Therefore, in most situations, no gain will be recognized, since the basis increase caused by allocating the COD income at the end of the tax year will offset the deemed cash distribution under Sec. 752(b). However, this will not always be the case, as indicated in the ruling's situation 2.

(This ruling is also discussed in the Tax Trends item, "Allocation of Partnership's COD Income May Have Substantial Economic Effect," TTA, Feb. 1993, at 137, and noted in the Tax Clinic item, "Tax Consequences in Partnership Debt Restructuring," TTA, Apr. 1993, at 245.)

Although the issue addressed in Rev. Rul. 92-97 deals with determining substantial economic effect under Sec. 704(b), in arriving at its conclusion the ruling expanded the scope of Regs. Sec. 1,731-1(a)(1)(ii), which states that advances or drawings of money or property against a partner's distributive share of income are treated as current distributions made on the last day of the partnership's tax year.

Since the COD income was integrally related to the Sec. 752(b) deemed cash distribution, the IRS reasoned that the deemed cash distribution was in the nature of an advance or draw against the COD income to be recognized at year-end, and thus was considered to be made on the last day of the partnership's tax year. Although one might argue that the Service "stretched" to make this conclusion, it is certainly a most reasonable result.

Rev. Rul. 92-97

A and B formed a partnership in which A contributed $10 and B contributed $90. They then borrowed $900 from a bank on a recourse basis and purchased property for $1,000. Only interest was due on the loan; the principal was all due and payable in six years. Other than depreciation, revenues equaled expenses. Depreciation deductions were $200 a year. Consequently, at the end of five years, the property was fully depreciated. A and B agreed that losses would be shared 10% by A and 90% by B. However, profits would be shared equally (that is, profits did not first offset prior loss allocations). In the beginning of year 6, as a result of a substantial decline in the property's value, the lender...