Author: Amanda M. Mills, CPA, Tax Senior Manager | Real Estate and Construction Industry Team
A taxpayer (other than a C corporation) who is not insolvent or bankrupt and receives income from discharged qualified real property business debt from a partnership interest may elect to exclude such income by reducing the inside basis of the partnership’s depreciable property. The election is made at the partner level by completing Form 982 (Reduction of Tax Attributes due to Discharge of Indebtedness (and Section 1082 Basis Adjustments)); however, the partnership must consent to reduce the partner’s basis in partnership property. To qualify for this exclusion, certain criteria must be met as outlined below.
First, the discharged debt must meet the definition of qualified real property business debt defined as (1) debt incurred or assumed before 1/1/93 in connection with real property used in a trade or business and that is secured by such real property or (2) on or after 1/1/93 and is qualified acquisition debt incurred or assumed to acquire, construct, reconstruct, or substantially improve real property used in a trade or business. Qualified real property business debt does not include qualified farm indebtedness but does include debt incurred to refinance qualified real property business debt provided the refinance does not exceed limitations set forth by the Code.
In general, the amount of income excluded cannot exceed the lesser of (1) the excess of the principal amount of the outstanding debt over the fair market value of the real property securing the debt, or (2) the aggregate adjusted bases of all depreciable real property held by the taxpayer. For refinanced debt, relief is available to the extent refinancing proceeds do not exceed the principal of the qualified real property business debt being refinanced. The adjustment to the basis of partnership property is treated in the same manner and has the same effect as an adjustment to the basis of the partnership property under section 743(b). Treas. Reg. Sec. 1.1017-1(g)(2)(v) provides a comprehensive example of how the basis reduction works in the initial year and subsequent years of adjustment including the disposition of the depreciable property.
The taxpayer can elect to exclude the discharged indebtedness from income by requesting that the partnership reduce the inside basis of its depreciable property. The partnership has sole discretion in granting or withholding consent and is not required to treat each partner consistently or provide reasoning for different treatment. However, the partnership must consent if (1) requests are made by partners owning (directly or indirectly) an aggregate of more than 80% of the capital and profits of the partnership or (2) five or fewer partners owning (directly or indirectly) an aggregate of more than 50% of the capital and profits interest in the partnership. A consent for request is required if, at the time of the discharge, the taxpayer owns (directly or indirectly) more than 50% of the partnership’s capital and profits, or if reductions to the basis of the taxpayer’s depreciable property are being made with respect to the taxpayer’s distributive share of discharged indebtedness income from the partnership.
Once requested, the partnership must provide written consent on or before the due date (including extensions) of the partner’s tax return for the year the discharge of indebtedness income is excluded by the taxpayer. The partnership must also attach a copy of the statement to its Form 1065 (U.S. Partnership Return of Income) for the partnership’s tax year following the year that ends with or within the tax year the partner excludes income. The basis reduction follows specific ordering rules and is deemed to occur at the beginning of the tax year following the tax year in which the discharge occurs or, if the property is disposed of, immediately before disposition.
Upon receipt of the partnership’s consent, the taxpayer must attach Form 982 (Reduction of Tax Attributes due to Discharge of Indebtedness (and Section 1082 Basis Adjustments)) to their timely filed tax return. For tax years beginning after December 31, 2012, taxpayers must retain the consent statement and keep it available for inspection but are not required to attach it to their return. The election is revocable only with IRS consent.
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