A recent article in the Tax Management Real Estate Journal, “Is It the End or Just the Beginning: Planning with The Final Partnership Debt-for-Equity Regulations,” 28 Real Estate Journal 39 (2/1/2012), discusses the final regulations under §108(e)(8) and §721, and illustrates electing liquidation value to minimize income from discharge of indebtedness. The article also discusses some practicalities relating to partnership agreements such as ensuring consistent treatment, determining the liquidation value, and restrictions on future redemptions of the lender, as well as the need for careful planning to realize the lenders’ loss.

In the examples, the authors observe that the built-in loss asset “disappears” after its contribution to the partnership and the creditor is left with a deferred capital loss in the basis of its partnership interest. The authors’ examples treat the transaction as a contribution by the creditor of property, i.e., debt, to the debtor-partnership in exchange for an interest. That, however, is not the only way the transaction could be viewed. The transaction could be viewed as the creditor’s assumption of the partnership’s debt, perhaps in a situation where the creditor is already a partner immediately before the discharge. From that perspective, would the tax consequences be the same? 

A related “disappearing” debt situation might arise in a contribution of property subject to debt owed to the creditor-partnership in exchange for an interest. Should the transaction be considered a transfer of part of the property to the partnership in satisfaction of the debt and a transfer of the rest of the property as a contribution to the partnership in exchange for an interest? Should the transaction be considered a contribution of unencumbered property to the partnership in exchange for a partnership interest and a distribution of the partner’s note? Would the tax results be the same? What is the role of form in these transactions?

-Ryan Prillaman
Federal Tax Law Analyst