Cancellation Of Debt Income (§108):

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COD - General Rule

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The discharge of indebtedness (“COD income”) generally results in income to the borrower.

Treas. Reg. § 1.61-12(a).

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Exclusion of COD Income

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Certain taxpayers in dire financial situations, including insolvent taxpayers, may partially or fully exclude COD income. I.R.C. § 108(a)(1)(B).

COD income that is excluded causes a reduction in tax attributes I.R.C. §§ 108(b); 1017.

This reduction is treated as depreciation for purposes of Section 1245, which means once the assets is disposed of, the taxpayer generally realizes ordinary income to the extent of the COD income originally deferred. I.R.C. §1017(d).

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Cozzi v. Comm’r

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The moment it becomes clear that a debt will never be paid, such debt must be viewed as having been discharged. 88 TC 435 (1987).

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CCA 200818005

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Chief Counsel's Office extended Rev. Rul. 68-602 to apply not only to a parent's cancellation of the debt owed to it by a liquidating direct subsidiary, but also to the parent's cancellation of the debt owed to it by a second-tier subsidiary in connection with the liquidation of the direct subsidiary.

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FSA 1999-719

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Notes that the IRS is unsure on how to source COD income.

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Testing Insolvency within the Consolidated Group.

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Whether a corporation which is part of a consolidated group is insolvent is determined on a stand alone basis (i.e., the affiliated group’s assets are not attributed to the corporation).

Treas. Reg. § 1.1502-28(a)(1).

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Cancellation of Indebtedness Income in the Partnership Context: 92-53

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Under Rev. Rul. 92-53, the IRS held that for purposes of determining the insolvency of the partner receiving COD income, the partnership nonrecourse debt discharged is taken into consideration. However, the result is different where the partner is not insolvent. For example, see Rev. Rul. 91-31 where IRS held that a reduction in non-recourse, non-purchase money debt created COD income.

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Cancellation of Indebtedness Income in the Partnership Context: 92-97

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Rev. Rul. 92-97 addresses substantial economic effect in the context of cancellation of indebtedness income. Also concludes that the deemed distribution under Section 752(b) should be treated as an advance or draw. These issues are also considered in Rev. Rul. 94-4.

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COD - Foreclosures versus COD

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Where property is foreclosed, the debtor’s amount realized is the amount of the nonrecourse debt, even where the debt exceeds the property’s value. Tufts v. Commissioner, 461 US 300 (1983).

However, if the debt exceeds the property’s value and the excess amount is cancelled by the creditor who is not a seller of the property, the cancellation is cancellation of indebtedness income. Rev. Rul. 91-31, 1991-1 CB 19.