Taxpayers receive time for canceled real-property debt election

Plain-English summary

Two taxpayers indirectly owned partnerships whose debt for business real estate was forgiven. Their tax adviser intended to elect the qualified real property business indebtedness exclusion, excluded the canceled debt income, and reduced property basis, but inadvertently omitted Form 982 and made errors in the partnerships' reporting and the timing of the basis reduction. The IRS found that the taxpayers reasonably relied on the adviser and that relief would not prejudice the government. It granted 45 days to file an amended return with Form 982 and to amend the partnerships' returns for the two affected years, with the required basis reduction reflected in the later year. The ruling did not decide whether the discharge produced cancellation-of-debt income or whether that income actually qualified for the exclusion.

Ruling snapshot

• Question: Could the taxpayers make a late election to exclude qualified real property business indebtedness income?
• Outcome: Approved, with 45 days to correct the taxpayer and partnership returns.
• Key authorities: IRC §§ 108(c)(3)(C) and 1017; Treas. Reg. §§ 1.108-5(b), 1.1017-1, and 301.9100-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202119004 Third Party Communication: None
Release Date: 5/14/2021 Date of Communication: Not Applicable
Index Number: 108.00-00, 108.01-00,
108.01-04, 108.02-00, Person To Contact:
9100.00-00 ------------------, ID No. -----------------
Telephone Number:
-------------------------------- --------------------
----------------------- Refer Reply To:
-------------------------------------------- CC:ITA:B04
PLR-118183-20
Date:
February 17, 2021

Legend

Taxpayers = ------------------------------------

State = ------------------
Year 1 = --------------------------
Year 2 = -------
Entity A = -----------------------------------
Entity B = ---------------------------
Entity C = -----------------------------------------
Firm = ----------------------------------------------

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

This letter responds to your request for an extension of time under § 301.9100-3 of the
Procedure and Administration Regulations to make a regulatory election. Specifically,
Taxpayers have requested an extension of time to make an election under section
108(c)(3)(C) of the Internal Revenue Code of 1986, as amended (IRC), and § 1.108-
5(b) of the Income Tax Regulations, with respect to discharge of indebtedness income,
effective for Taxpayers’ Year 1 federal income tax return.

This letter ruling is being issued electronically in accordance with Rev. Proc. 2020-29,
2020-21 I.R.B. 859. A paper copy will not be mailed to Taxpayers.

                                                 FACTS

PLR-118183-20 2

Entity A and Entity B are State limited partnerships taxed as a partnership for federal
income tax purposes and are indirectly wholly owned by Taxpayers. Entity A and Entity
B borrowed money from Entity C to fund the acquisition of several real property assets
which then were used in the trade or business of Entity A and Entity B. The loans were
evidenced by notes and were secured by the real property assets. In Year 1, the loans
were forgiven as part of a new market tax credit transaction.

Taxpayers engaged Firm, a qualified tax professional with many years of experience, to
prepare the federal income tax returns for Taxpayers, Entity A and Entity B for the tax
year ended Year 1.

Taxpayers provided Firm with the relevant facts regarding the debt forgiveness that
happened in Year 1. Firm discussed the Year 1 cancellation of debt with Taxpayers
and researched the matter and facts. Firm concluded that such debt was “qualified real
property business indebtedness” within the meaning of § 108(c)(3), as (i) the debt was
incurred in connection with the acquisition of real property used in a trade or business
and secured by such property, and (ii) the debt was incurred after January 1, 1993 to
acquire, construct, reconstruct, or substantially improve such real property.

Firm advised Taxpayers that the income from the discharge of the “qualified real
property indebtedness” was excludable from Taxpayers gross income under §§
108(a)(1)(D) and 108(c). Taxpayers discussed the availability of an election pursuant to
§ 108(c)(3)(C) with Firm and was advised that the basis of the real property would have
to be reduced in order for the income from discharge of indebtedness to be excluded
from Taxpayers’ gross income. Firm understood that Taxpayers wanted to make an
election under § 108(c)(3)(C) to exclude the income from discharge of indebtedness
from Taxpayers gross income.

Accordingly, Firm prepared Taxpayers’ federal income tax return for Year 1 excluding
the income from the discharge of indebtedness from gross income and reduced the
assets’ basis pursuant to §§ 108 and 1017. Taxpayers reviewed the federal income tax
return and the taxable income reflected the expected excluded income from the
discharge of indebtedness under §§ 108(a)(1)(D) and 108(c).

Firm also prepared the Year 1 Form 1065 for Entity A and the Year 1 Form 1065 for
Entity B along with the relevant Schedule K-1s. At the direction of Firm, each of Entity A
and Entity B reduced the basis of the depreciable real property previously secured by
the promissory notes on their respective Form 1065 by creating negative depreciable
assets that equaled the amount of the forgiven debt and the relevant Schedule K-1s
excluded the income from discharge of indebtedness.

During the preparation of Taxpayers’ Year 2 federal income tax return, Firm discovered
that the relevant Form 982 (Reduction of Tax Attributes Due to Discharge of
Indebtedness (and Section 1082 Basis Adjustment)) (“Form 982”) was inadvertently
omitted from the Year 1 federal income tax return and therefore, the § 108(c)(3)(C)
PLR-118183-20 3

election was not effectively made, despite excluding the income from discharge of
indebtedness from the Taxpayers’ gross income and reducing the basis the depreciable
real property previously secured by such indebtedness.

Additionally, Firm concluded that both Entity A and Entity B’s Year 1 Form 1065 should
have shown the income from discharge of indebtedness which would then be excluded
by Taxpayers on the Year 1 federal income tax return. In addition, Entity A and Entity
B’s treatment of reduction of basis was erroneously made on the respective Year 1
Form 1065s, as pursuant to § 1017(a)(1) and § 1.1017-1(a) the reduction of basis
should be made on the first day of the taxable year following the taxable year that the
taxpayer excluded the discharge of indebtedness income and should be made as a
reduction of the adjusted basis of the property and not as a negative asset as presented
on both Entity A and Entity B’s Year 1 Form 1065. If such request is granted, Taxpayers
intend to amend their Year 1 Tax Return to correctly reflect the requirements of §
1.1017-1. Taxpayers also intend to cause Entity A and Entity B to file amended Year 1
and Year 2 Form 1065’s to properly reflect the §108(c)(3)(C) election.

Taxpayers represent that (i) Taxpayers’ adjusted basis in the depreciable property is
greater than the amount of the cancellation of debt income and (ii) Taxpayers did not
exclude an amount under § 108(a)(1)(D) that exceeded the excess of the principal
amount of indebtedness over the fair market value of the real property.

Taxpayers are not accountants or tax professionals. Taxpayers were not aware of the
requirement that a Form 982 was required to be included with Taxpayers individual
federal income tax return and Firm did not advise Taxpayers that Form 982 was needed
to make an effective election.

In separate affidavits, Taxpayers and Firm represent that Taxpayers had communicated
their intention to make the Section 108(c)(3)(C) election to Firm, Firm was ultimately
responsible for making the election, and Form 982 was inadvertently omitted by Firm
from Taxpayers’ Year 1 federal income tax return.

                             LAW AND ANALYSIS

Section 61(a) of the Code provides, in part, that except as otherwise provided in this
subtitle, gross income means all income from whatever source derived. The statute then
specifically lists income from discharge of indebtedness as one of the items within the
scope of the term income. See § 61(a)(11).

Section 108(a)(1)(D) provides that gross income does not include any amount that (but
for § 108(a)) would be includible in gross income by reason of the discharge of
indebtedness if, in the case of a taxpayer other than a C corporation, the indebtedness
discharged is qualified real property business indebtedness.
PLR-118183-20 4

Section 108(c)(1) provides that the amount excluded from gross income under §
108(a)(1)(D) shall be applied to reduce the basis of the depreciable real property of the
taxpayer.

Section 108(c)(2)(A) provides, in general, that the amount excluded under §
108(a)(1)(D) with respect to any qualified real property business indebtedness shall not
exceed the excess of the outstanding principal amount of such indebtedness
(immediately before the discharge) over the fair market value of the real property
described in § 108(c)(3)(A) (as of such time).

Section 108(c)(3)(C) requires a taxpayer to make an election to exclude COD income
under § 108(a)(1)(D).

Section 108(d)(6) provides that in the case of a partnership, § 108(a) and § 108(c) are
applied at the partner level.

Section 1.108-5(b) provides that the election under § 108(c)(3)(C) is made on the timely
filed (including extensions) federal income tax return for the taxable year in which the
taxpayer has discharge of indebtedness income that is excludible from gross income
under § 108(a). The election is made on a completed Form 982, Reduction of Tax
Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).

Sections 301.9100-1 through 301.9100-3 provide the standards that the Service will use
to determine whether to grant an extension of time to make a regulatory election.
Section 301.9100-3(a) provides that requests for extensions of time for regulatory
elections (other than automatic changes covered in § 301.9100-2) will be granted when
the taxpayer provides evidence (including affidavits) to establish that the taxpayer acted
reasonably and in good faith, and granting relief will not prejudice the interests of the
Government.

Section 301.9100-3(b) provides that a taxpayer is deemed to have acted reasonably
and in good faith if the taxpayer requests relief before the failure to make the regulatory
election is discovered by the Internal Revenue Service, or reasonably relied on a
qualified tax professional, and the tax professional failed to make, or advise the
taxpayer to make, the election. However, a taxpayer will not be considered to have
reasonably relied on a qualified tax professional if the taxpayer knew or should have
known that the professional was not competent to render advice on the regulatory
election or was not aware of all relevant facts.

Section 301.9100-3(b)(3) provides that a taxpayer is deemed to have not acted
reasonably and in good faith if the taxpayer –

   (i) seeks to alter a return position for which an accuracy-related penalty
   could be imposed under § 6662 at the time the taxpayer requests relief

PLR-118183-20 5

   and the new position requires or permits a regulatory election for which
   relief is requested;

   (ii) was informed in all material respects of the required election and
   related tax consequences, but chose not to file the election; or

   (iii) uses hindsight in requesting relief.

Section 301.9100-3(c)(1) provides that the Commissioner will grant a reasonable
extension of time to make the regulatory election only when the interests of the
Government will not be prejudiced by the granting of relief.

Section 301.9100-3(c)(1)(i) provides that the interests of the Government are prejudiced
if granting relief would result in a taxpayer having a lower tax liability in the aggregate
for all taxable years affected by the election than the taxpayer would have had if the
election had been timely made (taking into account the time value of money). Similarly,
if the tax consequences of more than one taxpayer are affected by the election, the
Government's interests are prejudiced if extending the time for making the election may
result in the affected taxpayers, in the aggregate, having a lower tax liability than if the
election had been timely made.

Section 301.9100-3(c)(1)(ii) provides that the interests of the government are ordinarily
prejudiced if the taxable year in which the regulatory election should have been made or
any taxable year that would have been affected by the election had it been timely made
are closed by the period of limitations on assessment under § 6501(a) before the
taxpayer's receipt of a ruling granting relief under this section.

Under the facts submitted by Taxpayers, we conclude that Taxpayers have acted
reasonably and in good faith under §301.9100-3(b). In addition, we conclude that
granting relief will not prejudice the interests of the government under § 301.9100-3(c).

                                    CONCLUSION

Accordingly, based solely on the facts and information submitted and the
representations made in the ruling request, we grant Taxpayers an extension of 45 days
from the date of this letter to file an amended return to make an election under Code
Section 108(c)(3)(C) and Treas. Reg. § 1.108-5(b). The election is to be made on Form
982 as required by § 108(c)(1) in making this election, Taxpayers will reduce basis in
their depreciable real property on their Year 2 tax return to the extent that would have
been required if the election had been timely made on the original return.

Additionally, within 45 days of the date of this letter, Taxpayers are also required to
amend Entity A and Entity B’s Year 1 and Year 2 Form 1065s to properly reflect the §
108(c)(3)(C) election and the requirements of § 1.1017-1.
PLR-118183-20 6

                                     CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, this letter does not rule on whether the amount of income at
issue is properly treated as cancellation of indebtedness income under §61(a)(11). In
addition, this letter also does not rule on whether the income in fact qualifies for
exclusion from income under §108.

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

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being faxed to your authorized representative.

                                       Sincerely,



                                       Angella L. Warren
                                       Branch Chief, Branch 4
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)

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