Basis Reduction Due to Discharge of Indebtedness

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-208172-91]

RIN 1545-AU71

Basis Reduction Due to Discharge of Indebtedness

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide

ordering rules for the reduction of bases of property under sections

108 and 1017 of the Internal Revenue Code of 1986. The regulations will

affect taxpayers that exclude discharge of indebtedness from gross

income under section 108.

DATES: Written comments must be received by April 7, 1997. Outlines of

oral comments to be presented at the public hearing scheduled for April

24, 1997, at 10 a.m. must be received by April 3, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-208172-91), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG-208172-91), Courier's Desk, Internal Revenue Service, 1111

Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers may

submit comments electronically via the internet by selecting the ``Tax

Regs'' option on the IRS Home Page, or by submitting comments directly

to the IRS internet site at http://www.irs.ustreas.gov/prod/tax__regs/

comments.html.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations generally,

Sharon L. Hall or Christopher F. Kane of the Office of Assistant Chief

Counsel (Income Tax & Accounting) at (202) 622-4930; concerning

partnership adjustments under section 1017, Brian M. Blum of the Office

of Assistant Chief Counsel (Passthroughs & Special Industries) at (202)

622-3050; concerning submissions and the hearing, Evangelista C. Lee of

the Regulations Unit at (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in this notice of proposed

rulemaking have been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)).

Comments on the collections of information should be sent to the

Office of Management and Budget, Attn: Desk Officer for the Department

of the Treasury, Office of Information and Regulatory Affairs,

Washington, DC 20503, with copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224.

Comments on the collections of information should be received by March

10, 1997. Comments are specifically requested concerning:

Whether the proposed collections of information are necessary for

the proper performance of the functions of the Internal Revenue

Service, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed

collections of information (see below);

How the quality, utility, and clarity of the information to be

collected may be enhanced;

How the burden of complying with the proposed collections of

information may be minimized, including through the application of

automated collection techniques or other forms of information

technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of service to provide information.

The collections of information in this proposed regulation are in

Secs. 1.108-4(b), 1.1017-1(e)(2), and 1.1017-1(f)(2) (ii) and (iii).

This information is required for a taxpayer to elect to reduce the

adjusted bases of depreciable property under section 108(b)(5), to

elect to treat section 1221(1) real property as either depreciable

property or depreciable real property, and to account for a partnership

interest as either depreciable property or depreciable real property.

This information will be used to determine

[[Page 956]]

whether taxpayers have properly reduced the bases of their properties.

The collections of information are required to obtain a benefit. The

likely respondents are individuals, farms, businesses or other for-

profit institutions, and small businesses or organizations.

Estimated total annual reporting burden: 100,000 hour.

Estimated average annual burden per respondent: 1 hour.

Estimated number of respondents: 100,000.

Estimated annual frequency of responses: On occasion.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

This notice contains proposed amendments to the income tax

regulations (26 CFR Parts 1 and 301) under sections 108 and 1017 of the

Internal Revenue Code of 1986 (Code). The amendments are proposed to

conform the regulations to amendments to sections 108 and 1017 made by

the Bankruptcy Tax Act of 1980, Pub. L. 96-589, Sec. 2, 94 Stat. 3389

(1980), 1980-2 C.B. 607 (Bankruptcy Tax Act); the Technical Corrections

Act of 1982, Pub. L. 97-448, Sec. 102(h)(1), 96 Stat. 2365, 2372

(1983), 1983-1 C.B. 451; the Deficit Reduction Act of 1984, Pub. L. 98-

369, Secs. 474(r)(5) and 721(b)(2), 98 Stat. 494, 839, 966 (1984),

1984-3 C.B. (Vol. 1) 1; the Tax Reform Act of 1986, Pub. L. 99-514,

Secs. 104(b)(2), 231(d)(3)(D), 822, and 1171(b)(4), 100 Stat. 2085,

2105, 2179, 2373, 2513 (1986), 1986-3 C.B. (Vol. 1) 2; and the Omnibus

Budget Reconciliation Act of 1993, Pub. L. 103-66, Sec. 13150, 107

Stat. 312, 446 (1993), 1993-3 C.B. 1.

In general, section 108 excludes from gross income discharges of

indebtedness if the discharge occurs in a title 11 case or when the

taxpayer is insolvent, or if the indebtedness is ``qualified farm

indebtedness'' or ``qualified real property business indebtedness.''

Taxpayers generally must reduce specified tax attributes, including

adjusted bases of properties, to the extent income from discharge of

indebtedness is excluded from gross income under section 108. Section

1017 provides rules regarding any basis reductions required by, or

elected under, section 108.

Explanation of Provisions

Overview

The legislative history of the Bankruptcy Tax Act states that the

exclusion of discharge of indebtedness (COD income) from gross income

under section 108 is intended to promote a debtor's fresh start. S.

Rep. No. 1035, 96th Cong., 2d Sess. 10 (1980), 1980-2 C.B. 620, 624;

H.R. Rep. No. 833, 96th Cong., 2d Sess. 11 (1980). The exclusion

provided by the statute generally operates, however, to defer, rather

than eliminate, income from discharge of indebtedness.

The deferral of income provided by statute is generally achieved by

requiring a taxpayer to reduce specified tax attributes (including

adjusted bases of property) under section 108(b) by an amount equal to

the COD income excluded from gross income under section 108(a). Section

108(b)(2) requires a taxpayer to reduce tax attributes in the following

order: (A) net operating loss; (B) general business credit; (C) minimum

tax credit; (D) capital loss carryovers; (E) adjusted bases of

property; (F) passive activity loss and credit carryovers; and (G)

foreign tax credit carryovers. If the excluded COD income exceeds the

sum of the taxpayer's tax attributes, the excess is permanently

excluded from the taxpayer's gross income.

When basis reductions are necessary, section 1017(a) requires the

taxpayer to reduce the adjusted bases of property held on the first day

of the following tax year. Section 1017(b)(1) provides that the amount

of the basis reduction required under section 1017(a), and the

particular properties the bases of which are to be reduced, shall be

determined under regulations.

General Rules for Basis Reduction

Consistent with the legislative history of the Bankruptcy Tax Act,

the proposed regulations generally retain the ``tracing'' approach of

the existing regulations issued under prior law. Thus, the proposed

regulations require a taxpayer to reduce the adjusted basis of the

property that secured the discharged indebtedness before reducing the

adjusted bases of other property.

In addition, the proposed regulations modify the categories in the

existing regulations to simplify the process of basis reduction. First,

the distinction between purchase-money indebtedness and other secured

indebtedness is eliminated. Second, the order of basis reduction for

property that secured discharged indebtedness is changed. Thus, the

first category of the general ordering rule is real property used in

the taxpayer's trade or business or held for the production of income

(other than section 1221(1) real property) that secured the discharged

indebtedness, and the second category is personal property used in the

taxpayer's trade or business or held for the production of income

(other than inventory, accounts receivable, and notes receivable) that

secured the discharged indebtedness. Therefore, if an indebtedness

secured by a building, a parcel of land used in the taxpayer's trade or

business, office equipment, and office furniture is discharged, the

taxpayer proportionately reduces the adjusted bases of the building and

the parcel of land, based upon their relative adjusted bases, to the

full extent of the excluded COD income before reducing the adjusted

bases of the office equipment and the office furniture. The IRS and

Treasury Department believe that this modification of the current

regulations will simplify the process of basis reduction for many

taxpayers.

Special Rules for Depreciable Properties

Instead of reducing tax attributes in the order specified by

section 108(b)(2), a taxpayer may elect under section 108(b)(5) first

to reduce the adjusted bases of depreciable property (real and

personal) to the extent of the excluded COD income. If the adjusted

bases of depreciable property are insufficient to offset the entire

amount of excluded COD income, the taxpayer must reduce any remaining

tax attributes in the order specified in section 108(b)(2). Section

108(c) requires that excluded COD income from the cancellation of

qualified real property business indebtedness must be applied against

depreciable real property.

Section 1017(b)(3)(C) provides that a taxpayer must treat a

partnership interest as depreciable property when reducing adjusted

bases under section 108(b)(5), and as depreciable real property when

reducing adjusted bases under section 108(c), to the extent the

partnership correspondingly reduces the partner's proportionate

interest in the adjusted bases of depreciable property (or depreciable

real property) held by the partnership (inside basis).

The proposed regulations generally provide that a taxpayer may

freely choose whether or not to request that a partnership reduce the

partner's share of depreciable basis in partnership property and

thereby permit the taxpayer to treat the partnership interest

[[Page 957]]

as depreciable property (or depreciable real property). In addition,

the proposed regulations generally provide that the partnership is free

to grant or deny its consent. In order to prevent avoidance of the

general ordering rules of the proposed regulations through the use of

partnerships, however, a partner is required to request consent if the

partner owns (directly or indirectly) more than 50 percent of the

capital and profits interests of the partnership, or if the partner

receives a distributive share of COD income from the partnership. In

addition, the partnership is required to grant consent if requests are

made by partners owning (directly or indirectly) an aggregate of more

than 50 percent of the capital and profits interests of the

partnership.

The proposed regulations provide that a partner requesting a

reduction in inside basis must make the request before the due date

(including extensions) for filing the partner's Federal income tax

return for the taxable year in which the partner has COD income. A

partnership that consents to a basis reduction must include a consent

statement with its Form 1065, U.S. Partnership Return of Income, and

must also provide a copy of that statement to the affected partner on

or before the date the Form 1065 is filed. The IRS and Treasury

Department recognize that under current law a partner may not always

have sufficient information with which to decide to request a basis

reduction until on, or shortly before, the due date (including

extensions) for filing the partner's tax return. For example, for

calendar year taxpayers, a partner's tax return and a partnership's

Form 1065 are generally due on the same day. See sections 6031 and

6072. Comments are requested as to whether additional rules (such as

requiring a partnership to inform partners of COD income prior to the

date the Form 1065 is filed) are necessary to ensure that information

is exchanged between the partnership and its partners in a timely

fashion.

The proposed regulations remove Sec. 301.9100-13T, which governs

elections under section 108(b)(5), and add new proposed Sec. 1.108-4.

Under the temporary regulations, a taxpayer is required to make the

election with the taxpayer's Federal income tax return for the taxable

year in which the discharge occurs, but is permitted to file an

election with an amended return, or claim for credit or refund, if the

taxpayer establishes reasonable cause for failing to file the election

with the original return. New proposed Sec. 1.108-4 requires the

taxpayer to make the election on the timely filed (including

extensions) Federal income tax return for the taxable year the taxpayer

has COD income that is excluded under section 108(a). Therefore, a

taxpayer that fails to make the election on that return must request

the Commissioner's consent to file a late election under Sec. 301.9100-

3T or any regulations that supersede Sec. 301.9100-3T.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required.

Pursuant to section 7805(f) of the Internal Revenue Code, this

notice of proposed rulemaking will be submitted to the Chief Counsel

for Advocacy of the Small Business Administration for comment on its

impact on small business. Initial Regulatory Flexibility Act Analysis

This initial analysis is required under the Regulatory Flexibility

Act (5 U.S.C. chapter 6). In certain circumstances, the proposed

regulations will require a partnership to include a statement with its

Form 1065, U.S. Partnership Return of Income, and provide a copy of

that statement with the taxpayer's Schedule K-1 (Form 1065), Partner's

Share of Income, Credits, Deductions, etc., for the taxable year in

which the COD income is excluded under section 108(a), stating the

amount of the partner's share of the reduction in the partnership's

adjusted bases of depreciable real or personal property (inside basis).

This requirement will ensure that the partner knows it is entitled to

reduce the adjusted basis of the partnership interest and that the

affected partnership knows it must reduce the partner's interest in

inside basis. The legal basis for this requirement is contained in

sections 1017(b), 6001, and 7805(a).

Though the proposed regulations might affect any partnership owning

depreciable property, the IRS and Treasury Department believe that

partnerships owning depreciable real property are the most likely to be

affected. Approximately 1,560,000 partnership returns were filed for

1993. Approximately 620,000 of these were for partnerships owning real

property. It is unlikely, however, that many of these partnerships will

be affected by the proposed regulations in any given year.

After a partner conveys information concerning the amount of COD

income excluded from gross income under section 108(a) to the affected

partnership, the partnership must reduce the partner's interest in

inside basis. Accordingly, the partnership must prepare and maintain

special entries on its books because this basis reduction will reduce

the partner's share of the partnership's depreciation deductions, and

ultimate gain or loss on the sale of the property, in subsequent years.

In many cases, partnership returns are prepared using computer software

that can prepare and maintain these special entries after the initial

year.

The IRS and Treasury Department are not aware of any federal rules

that may duplicate, overlap, or conflict with the proposed rule.

As an alternative to the disclosure described above, the IRS and

Treasury Department considered, but rejected as too burdensome, a rule

that would have required an affected partnership to disclose the

reductions of adjusted basis on a property-by-property basis. There are

no known alternative rules that are less burdensome to small entities

but that accomplish the purpose of the statute. The IRS and Treasury

Department request comments from small entities concerning possible

alternatives.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the IRS. All

comments will be available for public inspection and copying.

A public hearing has been scheduled for April 29, 1997, at 10 a.m.

in IRS Auditorium, 7th Floor, Internal Revenue Building, 1111

Constitution Avenue, NW., Washington, DC. Because of access

restrictions, visitors will not be admitted beyond the Internal Revenue

Building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must

submit written comments by April 7, 1997 and submit an outline of the

topics to be discussed and the time to be devoted to each topic (signed

original and eight (8) copies) by April 3, 1997.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these regulations is Leo F. Nolan II,

Office of Assistant Chief Counsel (Income Tax

[[Page 958]]

and Accounting). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as

follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for 26 CFR part 1 is amended by

adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.108-4 also issued under 26 U.S.C. 108.

Section 1.108-5 also issued under 26 U.S.C. 108.

Section 1.1017-1 also issued under 26 U.S.C. 1017.

Sec. 1.108(a)-1 [Removed]

Par. 2. Section 1.108(a)-1 is removed.

Sec. 1.108(a)-2 [Removed]

Par. 3. Section 1.108(a)-2 is removed.

Sec. 1.108(b)-1 [Removed]

Par. 4. Section 1.108(b)-1 is removed.

Sec. 1.1016-7 [Removed]

Par. 5. Section 1.1016-7 is removed.

Sec. 1.1016-8 [Removed]

Par. 6-7. Section 1.1016-8 is removed.

Sec. 1.1017-2 [Removed]

Par. 8. Section 1.1017-2 is removed.

Par. 9. Section 1.108-4 is added to read as follows:

Sec. 1.108-4 Election to reduce basis of depreciable property under

section 108(b)(5).

(a) Description. An election under section 108(b)(5) is available

whenever a taxpayer excludes discharge of indebtedness (COD income)

from gross income under sections 108(a)(1)(A), (B), or (C) (concerning

title 11 cases, insolvency, and qualified farm indebtedness,

respectively). See sections 108(d)(2) and (3) for the definitions of

title 11 case and insolvent. See section 108(g)(2) for the definition

of qualified farm indebtedness.

(b) Time and manner. To make an election under section 108(b)(5), a

taxpayer must enter the appropriate information on Form 982, Reduction

of Tax Attributes Due to Discharge of Indebtedness (and Section 1082

Basis Adjustment), and attach the form to the timely filed (including

extensions) Federal income tax return for the taxable year in which the

taxpayer has COD income that is excluded from gross income under

section 108(a). An election under this section may be revoked only with

the consent of the Commissioner.

(c) Effective date. This section is effective for elections

concerning discharges of indebtedness occurring on or after the date

these regulations are published as final regulations in the Federal

Register.

Par. 10. Section 1.108-5 is added to read as follows:

Sec. 1.108-5 Limitations on the exclusion of income from the discharge

of qualified real property business indebtedness.

(a) Indebtedness in excess of value. The amount excluded from gross

income under section 108(a)(1)(D) (concerning discharges of qualified

real property business indebtedness) shall not exceed the excess, if

any, of the outstanding principal amount of that indebtedness

immediately before the discharge over the net fair market value of the

qualifying real property, as defined in Sec. 1.1017-1(c)(1),

immediately before the discharge. For purposes of this section, net

fair market value means the fair market value of the qualifying real

property (notwithstanding section 7701(g)) reduced by the outstanding

principal amount of any other qualified real property business

indebtedness secured by that property immediately before and after the

discharge.

(b) Overall limitation. The amount excluded from gross income under

section 108(a)(1)(D) shall not exceed the aggregate adjusted bases of

all depreciable real property held by the taxpayer immediately before

the discharge (other than depreciable real property acquired in

contemplation of the discharge) reduced by the sum of any--

(1) Depreciation claimed for the taxable year the taxpayer excluded

discharge of indebtedness from gross income under section 108(a)(1)(D);

and

(2) Reductions to the adjusted bases of depreciable real property

required under section 108(b) or section 108(g) for the same taxable

year.

(c) Effective date. This section is effective for discharges of

qualified real property business indebtedness occurring on or after the

date these regulations are published as final regulations in the

Federal Register.

Par. 11. Section 1.1017-1 is revised to read as follows:

Sec. 1.1017-1 Basis reductions following a discharge of indebtedness.

(a) General rule for section 108(b)(2)(E). This paragraph (a)

applies to basis reductions under section 108(b)(2)(E) that are

required by section 108(a)(1) (A) or (B) because the taxpayer excluded

discharge of indebtedness (COD income) from gross income. A taxpayer

must reduce in the following order, to the extent of the excluded COD

income but not below zero, the adjusted bases of property held on the

first day of the taxable year following the taxable year that the

taxpayer excluded COD income from gross income (in proportion to

adjusted basis):

(1) Real property used in a trade or business or held for

investment, other than real property described in section 1221(1), that

secured the discharged indebtedness immediately before the discharge

(see paragraph (f)(1) of this section for the treatment of partnership

indebtedness as indebtedness secured by the taxpayer's interest in the

partnership);

(2) Personal property used in a trade or business or held for

investment, other than inventory, accounts receivable, and notes

receivable, that secured the indebtedness immediately before the

discharge (see paragraph (f)(1) of this section for the treatment of

partnership indebtedness as indebtedness secured by the taxpayer's

interest in the partnership);

(3) Remaining property used in a trade or business or held for

investment, other than inventory, accounts receivable, notes

receivable, and real property described in section 1221(1);

(4) Inventory, accounts receivable, notes receivable, and real

property described in section 1221(1); and

(5) Property not used in a trade or business nor held for

investment.

(b) Operating rules--(1) Prior tax-attribute reduction. The amount

of excluded COD income applied to reduce basis does not include any COD

income applied to reduce tax attributes under sections 108(b)(2) (A)

through (D) and, if applicable, section 108(b)(5). For example, if a

taxpayer excludes $100 of COD income from gross income under section

108(a) and reduces tax attributes by $40 under sections 108(b)(2) (A)

through (D), the taxpayer is required to reduce the adjusted bases of

property by $60 ($100-$40) under section 108(b)(2)(E).

(2) Multiple discharged indebtednesses. If a taxpayer has COD

[[Page 959]]

income attributable to more than one discharged indebtedness resulting

in the reduction of tax attributes under sections 108(b)(2) (A) through

(D) and, if applicable, section 108(b)(5), paragraph (b)(1) of this

section must be applied by allocating the tax-attribute reductions

among the indebtednesses in proportion to the amount of COD income

attributable to each discharged indebtedness. For example, if a

taxpayer excludes $20 of COD income attributable to secured

indebtedness A and excludes $80 of COD income attributable to unsecured

indebtedness B (a total exclusion of $100), and if the taxpayer reduces

tax attributes by $40 under sections 108(b)(2) (A) through (D), the

taxpayer must reduce the amount of COD income attributable to secured

indebtedness A to $12 ($20 - ($20 $100 x $40)) and must

reduce the amount of COD income attributable to unsecured indebtedness

B to $48 ($80 - ($80 $100 x $40)).

(3) Limitation on basis reductions under section 108(b)(2)(E) in

bankruptcy or insolvency. If COD income arises from a discharge of

indebtedness in a title 11 case or while the taxpayer is insolvent, the

amount of any basis reduction under section 108(b)(2)(E) shall not

exceed the excess of--

(i) The aggregate of the adjusted bases of property and the amount

of money held by the taxpayer immediately after the discharge; over

(ii) The aggregate of the liabilities of the taxpayer immediately

after the discharge.

(c) Modification of ordering rules for basis reductions under

sections 108(b)(5) and 108(c)--(1) In general. The ordering rules

prescribed in paragraph (a) of this section apply, with appropriate

modifications, to basis reductions under sections 108 (b)(5) and (c).

Thus, a taxpayer may reduce only the adjusted bases of depreciable

property under section 108(b)(5) and may reduce only the adjusted bases

of depreciable real property under section 108(c). Furthermore, for

basis reductions under section 108(c), a taxpayer must reduce the

adjusted basis of the qualifying real property to the extent of the

discharged qualified real property business indebtedness before

reducing the adjusted bases of other depreciable real property. The

term qualifying real property means real property with respect to which

the indebtedness is qualified real property business indebtedness

within the meaning of section 108(c)(3). See paragraphs (e) and (f) of

this section for elections relating to section 1221(1) property and

partnership interests.

(2) Partial basis reductions under section 108(b)(5). If the amount

of basis reductions under section 108(b)(5) is less than the amount of

the COD income excluded from gross income under section 108(a), the

taxpayer must reduce the balance of its tax attributes, including any

remaining adjusted bases of depreciable property, under section

108(b)(2). For example, if a taxpayer excludes $100 of COD income from

gross income under section 108(a) and elects to reduce the adjusted

bases of depreciable property by $10 under section 108(b)(5), the

taxpayer must reduce its remaining tax attributes by $90 under section

108(b)(2).

(3) Modification of fresh start rule for prior basis reductions

under section 108(b)(5). After reducing the adjusted bases of

depreciable property under section 108(b)(5), a taxpayer must compute

the limitation on basis reductions under section 1017(b)(2) using the

aggregate of the remaining adjusted bases of property. For example, if,

immediately after the discharge of indebtedness in a title 11 case, a

taxpayer's adjusted bases of property is $100 and its undischarged

indebtedness is $70, and if the taxpayer elects to reduce the adjusted

bases of depreciable property by $10 under section 108(b)(5), section

1017(b)(2) limits any further basis reductions under section

108(b)(2)(E) to $20 (($100 - $10) - $70).

(d) Changes in security. Any change in the property securing an

indebtedness during the one-year period preceding the discharge of that

indebtedness shall be disregarded if a principal purpose of that change

is to affect the taxpayer's basis reductions under section 1017.

(e) Election to treat section 1221(1) real property as

depreciable--(1) In general. For basis reductions under sections 108

(b)(5) and (g), a taxpayer may elect under sections 1017(b) (3)(E) and

(4)(C), respectively, to treat real property described in section

1221(1) as depreciable property. This election is not available,

however, for basis reductions under section 108(c).

(2) Time and manner. To make an election under section 1017(b)

(3)(E) or (4)(C), a taxpayer must enter the appropriate information on

Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness

(and Section 1082 Basis Adjustment), and attach the form to a timely

filed (including extensions) Federal income tax return for the taxable

year in which the taxpayer has COD income that is excluded from gross

income under section 108(a). An election under this paragraph (e) may

be revoked only with the consent of the Commissioner.

(f) Partnerships--(1) Partnership COD income. For purposes of

paragraph (a) of this section, a taxpayer must treat a distributive

share of a partnership's COD income as attributable to a discharged

indebtedness secured by the taxpayer's interest in that partnership.

(2) Partnership interest treated as depreciable property--(i) In

general. For purposes of making basis reductions, if a taxpayer makes

an election under section 108 (b)(5) or (c) the taxpayer must treat a

partnership interest as depreciable property (or depreciable real

property) to the extent of the partner's proportionate share of the

partnership's basis in depreciable property (or depreciable real

property), provided the partnership consents to a corresponding

reduction in the partnership's basis (inside basis) in depreciable

property (or depreciable real property) with respect to such partner.

(ii) Request by partner and consent of partnership--(A) In general.

Except as otherwise provided in this paragraph (f)(2)(ii), a taxpayer

may choose whether or not to request that a partnership reduce the

inside basis of its depreciable property (or depreciable real property)

with respect to the taxpayer, and the partnership may grant or withhold

such consent, in its sole discretion. A request by the taxpayer must be

made before the due date (including extensions) for filing the

taxpayer's Federal income tax return for the taxable year in which the

taxpayer has COD income that is excluded from gross income under

section 108(a).

(B) Request for consent required. A taxpayer must request a

partnership's consent to reduce inside basis if the taxpayer owns

(directly or indirectly) a greater than 50 percent interest in the

capital and profits of the partnership, or if reductions to the basis

of the taxpayer's depreciable property (or depreciable real property)

are being made with respect to the taxpayer's distributive share of COD

income of the partnership.

(C) Granting of request required. A partnership must consent to

reduce its partners' shares of inside basis if consent is requested by

partners owning (directly or indirectly) an aggregate of more than 50

percent of the capital and profits interests of the partnership. For

example, if there is a cancellation of partnership indebtedness

securing real property used in a partnership's trade or business, and

if partners owning (in the aggregate) 60 percent of the capital and

profits interests of the partnership elect to exclude the COD income

under

[[Page 960]]

section 108(c), the partnership must make the appropriate reductions in

those partners' shares of inside basis.

(iii) Partnership consent statement--(A) Partnership requirement. A

consenting partnership must include with the Form 1065, U.S.

Partnership Return of Income, for the taxable year of the partnership

that ends with or within the taxable year the taxpayer excludes COD

income from gross income under section 108(a), and must provide to the

taxpayer on or before the date the Form 1065 is filed, a statement

that--

(1) Contains the name, address, and taxpayer identification number

of the partnership; and

(2) States the amount of the reduction of the partner's

proportionate interest in the adjusted bases of the partnership's

depreciable property or depreciable real property, whichever is

applicable.

(B) Taxpayer's requirement. Statements described in paragraph

(f)(2)(iii)(A) of this section must be attached to a taxpayer's timely

filed (including extensions) Federal income tax return for the taxable

year in which the taxpayer has COD income that is excluded from gross

income under section 108(a).

(iv) Partner's share of partnership's adjusted basis. [Reserved.]

(3) Partnership basis reduction. The rules of this section

(including this paragraph (f)), apply in determining the properties to

which the partnership's basis reductions must be made.

(g) Special allocation rule for cases to which section 1398

applies. If a bankruptcy estate and a taxpayer to whom section 1398

applies (concerning only individuals under Chapter 7 or 11 of title 11

of the United States Code) hold property subject to basis reduction

under section 108(b)(2)(E) or (5) on the first day of the taxable year

following the taxable year of discharge, the bankruptcy estate must

reduce all of the adjusted bases of its property before the taxpayer is

required to reduce any adjusted bases of property.

(h) Effective date. This section is effective for discharges of

indebtedness occurring on or after the date these regulations are

published as final regulations in the Federal Register.

PART 301--PROCEDURE AND ADMINISTRATION

Par. 12. The authority citation for part 301 continues to read as

follows:

Authority: 26 U.S.C. 7805 * * *

Sec. 301.9100-13T [Removed]

Par. 13. Section 301.9100-13T is removed.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 97-154 Filed 1-6-97; 8:45 am]

BILLING CODE 4830-01-U