Insolvent taxpayer could not revoke a basis-reduction election

Plain-English summary

An insolvent real estate professional excluded cancellation-of-debt income and, on professional advice, elected to reduce the basis of depreciable property before reducing net operating losses. After selling one property at a gain affected by the reduced basis, the taxpayer asked to revoke the election and claimed the adviser had not adequately explained its effect. The IRS found that the adviser's sworn statement showed repeated discussions and a deliberate choice to preserve the losses. Revocation would also lower tax liabilities, including gain on the later sale, and the taxpayer waited 17 months after discovering the issue to request relief. The IRS therefore denied permission to revoke the section 108(b)(5) election.

Ruling snapshot

• Question: Could the taxpayer revoke an election to reduce depreciable-property basis before other tax attributes?
• Outcome: denied
• Key authorities: IRC §§ 61(a)(12), 108(a)(1)(B), 108(b), 1017(b)(2); Treas. Reg. §§ 1.108-4(b), 301.9100-2

Full text (IRS public release)

Internal Revenue Service                        Department of the Treasury
                                                Washington, DC 20224

Number: 201718023                               [Third Party Communication:
Release Date: 5/5/2017                          Date of Communication: Month DD, YYYY]
Index Number: 108.01-02
                                                Person To Contact:
---------------------------                     ------------------------, ID No. ------------------
--------------------------------------------    ----------------------------------------------------
----------------------------                    Telephone Number:
                                                ----------------------
                                                Refer Reply To:
                                                CC:ITA:B04
                                                PLR-128523-16
                                                Date:
                                                January 31, 2017

Legend

Taxpayer = ---------------------------
TIN: ------------------
Year 1 = -------
Year 2 = -------
$X = --------------
$Y = ------------
Date 1 = ----------------------
Date 2 = ---------------------

Dear ---------------:

This is in reference to an election that Taxpayer made to reduce the basis of
depreciable property under section 108(b)(5) of the Internal Revenue Code by the
amount excluded from income under section 108(a)(1)(B). Taxpayer is requesting
permission to revoke that election pursuant to section 1.108-4(b) of the Income Tax
Regulations.

Taxpayer is a self-employed real estate professional. In Year 1, Taxpayer owned three
residential apartment buildings. Taxpayer had $X cancellation of indebtedness in --------
and had $Y net operating losses (NOLs). Taxpayer represents that it was insolvent in
Year 1.

Taxpayer filed an original Year 1 Federal income tax return to reduce tax attributes in
the order under section 108(b)(2). Upon the advice of an established mid-sized CPA
firm, Taxpayer filed an amended ------- Federal income tax return and elected to first
reduce basis against depreciable property under section 108(b)(5) to preserve its NOLs.
This amended return was a request under section 301.9100-2 of the Procedure and
Administration Regulations.
PLR-128523-16                                2

Taxpayer sold one of its properties in Year 2. Taxpayer’s current representative has
informed this office that Taxpayer sold this property at a gain. Taxpayer indicates in its
supplemental submission that much of its income in Year 2 was a result of the sale of
the property with the reduced basis as a result of the election under 108(b)(5).

                                    Law and Analysis

Section 61(a)(12) provides that gross income includes income from discharge of
indebtedness.

Section 108(a)(1)(B) provides that gross income does not include any amount that
would be includible in gross income by reason of the discharge of indebtedness of the
taxpayer if the discharge occurs when the taxpayer is insolvent.

Section 108(b)(1) provides that the amount excluded from gross income shall be
applied to reduce certain tax attributes of the taxpayer. Section 108(b)(2) provides, in
general, that the reduction shall be made to tax attributes in the following order: (A) net
operating losses, (B) general business credits, (C) minimum tax credits, (D) net capital
losses and capital loss carryovers, (E) basis of property, (F) passive activity losses, and
(G) foreign tax credit carryovers.

Section 108(b)(5) states that the taxpayer may elect to apply any portion of the amount
excluded from income to the reduction under section 1017 of the basis of the
depreciable property of the taxpayer. Section 108(b)(5)(B) provides that the basis
reduction shall not exceed the aggregate bases of the depreciable property held by the
taxpayer as of the beginning of the taxable year following the taxable year of the
discharge. Section 108(b)(5)(C) provides that the tax attributes under section 108(b)(2)
are not reduced if a taxpayer makes an election under section 108(b)(5).

Section 1017(b)(2) provides, in general, that in the event of exclusion from income of
discharge of indebtedness income by an insolvent taxpayer under section 108(a)(1)(B),
the reduction in basis of property shall not exceed the excess of the total bases of
property held by the taxpayer immediately after the discharge over the taxpayer's total
liabilities immediately after the discharge. However, this limitation does not apply to any
reduction in basis by reason of an election under section 108(b)(5). In this situation,
there would be no basis reduction limitation.

In the present case, Taxpayer engaged a qualified tax professional to amend its Year 1
Federal income tax return. Taxpayer submitted only one affidavit describing the
engagement from the tax professional engaged to amend its Year 1 Federal income tax
return. In that affidavit, the tax professional states, under penalties of perjury, that he
discussed the tax attribute reduction ordering rules under section 108(b)(2) and the
election under section 108(b)(5) to first reduce basis against depreciable property. In
the affidavit, the tax professional further states that, after numerous discussions, the
decision was made to utilize the election under section 108(b)(5) to preserve the NOLs.
PLR-128523-16                                3

Taxpayer asserts that, on Date 1, it became aware that it was not properly advised by
the tax professional about the effect of making the election under section 108(b)(5) by
an insolvent taxpayer. Some 17 months later, Taxpayer requested permission to
revoke that election pursuant to section 1.108-4(b) on Date 2.

Based on the information submitted, Taxpayer is not granted permission to revoke its
late section 108(b)(5) election made under section 301.9100-2 of the Procedure and
Administration Regulations. First, the sole affidavit prepared by Taxpayer’s tax
preparer states, under penalties of perjury, that he and Taxpayer had numerous
conversations about the tax attribute reduction ordering rules under section 108(b) and
the section 108(b)(5) election, and that Taxpayer, a real estate professional, decided to
make the election in order to preserve its NOLs. Taxpayer’s statements to the contrary
do not overcome the statements made by the tax professional that Taxpayer made a
deliberate decision to preserve its NOLs. Second, to allow Taxpayer to revoke its
section 108(b)(5) election would prejudice the interests of the government in that
Taxpayer would have a lower tax liability for all tax years (including by reducing, or
eliminating, any gain on sale of property in Year 2). Lastly, Taxpayer did not act
diligently and in good faith by waiting 17 months to request permission to revoke the
election. Therefore, permission to revoke the election under section 108(b)(5) is not
granted.

                                         Caveats

Except as expressly provided, we express no opinion concerning the tax consequences
of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayers and accompanied by a penalty of perjury statement
executed by the taxpayers. While this office has not verified any of the material
submitted in support of the request for a ruling, it is subject to verification on
examination.

                                      Sincerely,



                                      Donna Welsh
                                      Senior Technician Reviewer
                                      Office of Associate Chief Counsel
                                      (Income Tax & Accounting)