Application of Section 108(e)(8) to Indebtedness Satisfied by a Partnership Interest, 71255-71259 [2011-29553]
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Federal Register / Vol. 76, No. 222 / Thursday, November 17, 2011 / Rules and Regulations
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Dated: November 10, 2011.
Leslie Kux,
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[FR Doc. 2011–29701 Filed 11–16–11; 8:45 am]
BILLING CODE 4160–01–P
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9557]
RIN 1545–BF27
Application of Section 108(e)(8) to
Indebtedness Satisfied by a
Partnership Interest
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:
This document contains final
regulations relating to the application of
section 108(e)(8) of the Internal Revenue
Code (Code) to partnerships and their
partners. These regulations provide
guidance regarding the determination of
discharge of indebtedness income of a
partnership that transfers a partnership
interest to a creditor in satisfaction of
the partnership’s indebtedness. The
final regulations also address the
application of section 721 to a
contribution of a partnership’s recourse
or nonrecourse indebtedness by a
creditor to the partnership in exchange
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SUMMARY:
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for a capital or profits interest in the
partnership. Moreover, the final
regulations address how a partnership’s
discharge of indebtedness income is
allocated as a minimum gain chargeback
under section 704. The regulations
affect partnerships and their partners.
DATES: Effective Date: These regulations
are effective on November 17, 2011.
Applicability Date: For dates of
applicability, see §§ 1.108–8(d), 1.704–
2(l)(1)(v), and 1.721–1(d)(4).
FOR FURTHER INFORMATION CONTACT:
Joseph R. Worst or Megan A. Stoner,
Office of Associate Chief Counsel
(Passthroughs and Special Industries),
(202) 622–3070 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
generally applies to a contribution of a
partnership’s recourse or nonrecourse
indebtedness by a creditor to the
partnership in exchange for a capital or
profits interest in the partnership. A
public hearing on the proposed
regulations was scheduled for February
19, 2009, but was cancelled because no
one requested to speak. However,
comments responding to the proposed
regulations were received. After
consideration of these comments, the
proposed regulations are adopted as
revised by this Treasury decision. These
final regulations generally retain the
provisions of the proposed regulations
with the modifications discussed in the
preamble.
Background
This document contains amendments
to 26 CFR part 1 under sections 108,
704, and 721 of the Code relating to the
application of section 108(e)(8) to
partnerships.
Section 108(e)(8) was amended by
section 896 of the American Jobs
Creation Act of 2004, Public Law 108–
357 (118 Stat. 1648), to include
discharges of partnership indebtedness
occurring on or after October 22, 2004.
Prior to the amendment, section
108(e)(8) only applied to discharges of
corporate indebtedness. Section
108(e)(8), as amended, provides that, for
purposes of determining income of a
debtor from discharge of indebtedness
(COD income), if a debtor corporation
transfers stock or a debtor partnership
transfers a capital or profits interest in
such partnership to a creditor in
satisfaction of its recourse or
nonrecourse indebtedness, such
corporation or partnership shall be
treated as having satisfied the
indebtedness with an amount of money
equal to the fair market value of the
stock or interest. In the case of a
partnership, any COD income
recognized under section 108(e)(8) shall
be included in the distributive shares of
the partners in the partnership
immediately before such discharge.
A notice of proposed rulemaking and
a notice of public hearing (REG–
164370–05, 2008–46 IRB 1157) were
published in the Federal Register (73
FR 64903) on October 31, 2008,
proposing amendments to the
regulations regarding the application of
section 108(e)(8) to partnerships and
their partners, including the
determination of COD income of a
partnership that transfers a partnership
interest to a creditor in satisfaction of
the partnership’s indebtedness (debt-forequity exchange). The proposed
regulations also provide that section 721
Summary of Comments and
Explanation of Provisions
1. Valuation of Partnership Interest
Transferred in Satisfaction of
Partnership Indebtedness
Section 108(e)(8) provides that, for
purposes of determining COD income of
a debtor partnership, the partnership
shall be treated as having satisfied the
indebtedness with an amount of money
equal to the fair market value of the
interest transferred to the creditor.
Generally, the amount by which the
indebtedness exceeds the fair market
value of the partnership interest
transferred is the amount of COD
income required to be included in the
distributive shares of the partners that
were partners in the debtor partnership
immediately before the discharge.
The proposed regulations provide
that, for purposes of determining the
amount of COD income, the fair market
value of the partnership interest
transferred to the creditor in a debt-forequity exchange (debt-for-equity
interest) is the liquidation value of the
partnership interest if four requirements
are satisfied (liquidation value safe
harbor). For this purpose, liquidation
value equals the amount of cash that the
creditor would receive with respect to
the debt-for-equity interest if,
immediately after the transfer, the
partnership sold all of its assets
(including goodwill, going concern
value, and any other intangibles) for
cash equal to the fair market value of
those assets, and then liquidated.
The four conditions of the liquidation
value safe harbor in the proposed
regulations are that (i) The debtor
partnership determines and maintains
capital accounts of its partners in
accordance with the capital accounting
rules of § 1.704–1(b)(2)(iv) (capital
account maintenance requirement); (ii)
the creditor, debtor partnership, and its
partners treat the fair market value of
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the indebtedness as being equal to the
liquidation value of the debt-for-equity
interest for purposes of determining the
tax consequences of the debt-for-equity
exchange (consistency requirement);
(iii) the debt-for-equity exchange is an
arm’s-length transaction (arm’s-length
requirement); and (iv) subsequent to the
debt-for-equity exchange, neither the
partnership redeems nor any person
related to the partnership purchases the
debt-for-equity interest as part of a plan
at the time of the debt-for-equity
exchange which has as a principal
purpose the avoidance of COD income
by the partnership (anti-abuse
provision). If these requirements are not
satisfied, all of the facts and
circumstances are considered in
determining the fair market value of the
debt-for-equity interest for purposes of
applying section 108(e)(8). Each of the
four requirements of the proposed
regulations is discussed in the
preamble.
The first requirement is the capital
account maintenance requirement.
Commenters requested that the final
regulations clarify that this requirement
does not necessitate compliance with all
aspects of the substantial economic
effect safe harbor under § 1.704–1(b)(2),
notably the requirement that the
partnership liquidate in accordance
with the positive capital account
balances of its partners. To eliminate
confusion over the capital account
maintenance requirement in the
liquidation value safe harbor, the IRS
and the Treasury Department have
decided to remove the capital account
maintenance requirement from the
liquidation value safe harbor because
the maintenance of capital accounts is
not necessary to the determination of
the liquidation value of the partner’s
interest.
The second requirement of the
liquidation value safe harbor in the
proposed regulations is the consistency
requirement. This requirement is
intended to ensure consistent reporting
by the creditor, debtor partnership, and
its partners. One commenter suggested
narrowing the scope of this requirement
in the final regulations so that the
failure of a partner to consistently treat
the fair market value of the
indebtedness as being equal to the
liquidation value of the debt-for-equity
interest does not invalidate the
partnership’s use of the liquidation
value safe harbor, provided the creditor
and the partnership otherwise
consistently determine and report COD
income based on such valuation. The
IRS and the Treasury Department
considered the issue and decided to not
modify this requirement in the final
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regulations. The amount of COD income
computed under the liquidation value
safe harbor may differ from the amount
computed using the fair market value of
the partnership interest. Thus, in order
for the partnership to use the
liquidation value safe harbor, the IRS
and the Treasury Department believe
that the partnership and all of its
partners must report consistently.
One commenter suggested that
taxpayers should not be able to
selectively exploit to their benefit the
discrepancy between liquidation value
and fair market value and suggested that
the final regulations require that a
partnership apply a consistent valuation
methodology to all equity issued in any
debt-for-equity exchange that is part of
the same overall transaction. The IRS
and the Treasury Department agree, and
therefore the final regulations add this
as a condition to the liquidation value
safe harbor.
The third requirement of the
liquidation value safe harbor in the
proposed regulations is the arm’s-length
requirement. Commenters requested
that the final regulations clarify whether
this requirement can be satisfied where
the exchange is between the partnership
and an existing partner. The IRS and the
Treasury Department believe that the
liquidation value safe harbor should be
available where the transaction involves
related parties and have clarified this
requirement in the final regulations to
provide that, as long as the debt-forequity exchange has terms that are
comparable to terms that would be
agreed to by unrelated parties
negotiating with adverse interests, the
third requirement is satisfied even if the
transaction is between related parties.
The fourth requirement of the
liquidation value safe harbor in the
proposed regulations is an anti-abuse
provision. The final regulations follow
the anti-abuse provision of the proposed
regulations by adding a restriction on
subsequent purchases of the debt-forequity interest by a person related to
any partner (in addition to purchases by
a person related to the partnership) as
part of a tax-avoidance plan. Thus,
under the final regulations, the
partnership cannot redeem and no
person related to the partnership or to
any partner can purchase the debt-forequity interest as part of a plan at the
time of the debt-for-equity exchange that
has as a principal purpose the
avoidance of COD income by the
partnership. Commenters requested that
the final regulations clarify the meaning
of ‘‘related’’ in this context. The IRS and
the Treasury Department agree that
clarification is warranted and therefore
the final regulations refer to sections
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267(b) and 707(b) for the meaning of
‘‘related’’ in the anti-abuse provision.
The final regulations also address the
application of the liquidation value safe
harbor rule to a partnership (upper-tier
partnership) that directly or indirectly
owns an interest in one or more
partnerships (lower-tier partnership(s)).
The final regulations provide that, with
respect to interests held in one or more
lower-tier partnerships, the liquidation
value of an interest in an upper-tier
partnership is determined by taking into
account the liquidation value of such
lower-tier partnership interest.
The final regulations provide that if
the fair market value of the debt-forequity interest does not equal the fair
market value of the indebtedness
exchanged, then general tax law
principles shall apply to account for the
difference. Moreover, section
707(a)(2)(A), as it relates to the
treatment of payments to partners for
transfers of property, will be considered,
if appropriate.
2. Application of Section 721 to Debtfor-Equity Exchanges
The proposed regulations generally
provide that the nonrecognition rule of
section 721 applies to the debt-forequity exchange. Under the proposed
regulations, the creditor does not
recognize a loss or a bad debt deduction
in the debt-for-equity exchange. The
creditor’s basis in the debt-for-equity
interest is increased under section 722
by the adjusted basis of the
indebtedness. The preamble to the
proposed regulations requested
comments on alternative approaches.
A number of commenters agreed with
the general application of section 721 to
the debt-for-equity exchange, but
recommended that the rule be modified
in the final regulations. The commenters
argued that the application of section
721 to the debt-for-equity exchange may
result in asymmetry in the timing of the
partnership’s COD income inclusion
and the creditor’s loss, character
conversion for the creditor from
ordinary loss to capital loss, and
disparities between the partners’
aggregate bases in their partnership
interests and the partnership’s basis in
its assets. Some commenters suggested
that these results could be alleviated if
the final regulations bifurcate the debtfor-equity exchange into two
transactions, namely the cancellation of
a portion of the indebtedness, and the
contribution of the balance in exchange
for an interest in the partnership in a
transaction to which section 721 applies
(bifurcation approach). Another
commenter, however, stated that a
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bifurcation approach is not consistent
with section 721 or case law.
The IRS and the Treasury Department
agree with the latter comment and
believe that the bifurcation approach
would be inconsistent with the
treatment of analogous corporate debtfor-equity transactions involving
corporate indebtedness evidenced by a
security in which section 351 would
apply, for example. Further, comments
in favor of the bifurcation approach
assume a creditor has not validly taken
a bad debt deduction under section 166
prior to the debt-for-equity exchange in
a transaction independent of and
separate from the debt-for-equity
exchange. After consideration of the
issue, the IRS and the Treasury
Department have determined that the
final regulations will not adopt the
bifurcation approach.
3. Obligations for Unpaid Rent,
Royalties, and Interest
The proposed regulations provide that
section 721 does not apply to the
transfer of a partnership interest to a
creditor in satisfaction of a partnership’s
recourse or nonrecourse indebtedness
for unpaid rent, royalties, or interest on
indebtedness (including accrued
original issue discount). These items
generally give rise to ordinary income to
the creditor and a deduction to the
partnership. Most commenters agreed
that the general nonrecognition rule
under section 721 should not apply to
the transfer of a partnership interest in
satisfaction of these items. The IRS and
the Treasury Department believe that
the exception to section 721 for these
items is necessary to prevent the
conversion of ordinary income into
capital gain.
The final regulations retain the
exception for these ordinary income
items, but, in response to a comment,
limit the scope of the exception. The
commenter suggested that the exception
be limited to items that accrued on or
after the beginning of the creditor’s
holding period for the indebtedness.
The IRS and the Treasury Department
agree with the comment, and therefore,
the final regulations provide that section
721 does not apply to a debt-for-equity
exchange to the extent the partnership
interest is exchanged for the
partnership’s indebtedness for unpaid
rent, royalties, or interest on the
partnership’s indebtedness (including
accrued original issue discount) that
accrued on or after the beginning of the
creditor’s holding period for the
indebtedness.
The preamble to the proposed
regulations states the general rule that
when property is transferred as payment
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on indebtedness (or in satisfaction
thereof), gain or loss on the property is
recognized. Under that approach, in a
debt-for-equity exchange, if the
partnership is treated as satisfying its
indebtedness for unpaid rent, royalties,
or interest on indebtedness (including
accrued original issue discount) with a
fractional interest in each asset of the
partnership, the partnership could
recognize gain or loss equal to the
difference between the fair market value
of each partial asset deemed transferred
to the creditor and the adjusted basis in
that partial asset. The IRS and the
Treasury Department believe that in a
debt-for-equity exchange where the
partnership has not disposed of any of
its assets, the partnership should not be
required to recognize gain or loss on the
transfer of a partnership interest in
satisfaction of its indebtedness for
unpaid rent, royalties, or interest.
Therefore, under the final regulations, a
debtor partnership will not recognize
gain or loss upon the transfer of a
partnership interest to a creditor in a
debt-for-equity exchange for unpaid
rent, royalties, or interest that accrued
on or after the beginning of the
creditor’s holding period for the
indebtedness.
4. COD Income as First-Tier Item for
Minimum Gain Chargeback Rules
The preamble to the proposed
regulations requested comments
regarding the manner in which COD
income arising from a debt-for-equity
exchange should be treated for purposes
of the minimum gain chargeback rules
under § 1.704–2(f)(6). Section 1.704–
2(f)(6) provides that any minimum gain
chargeback required for a partnership
taxable year consists first of certain
gains recognized from the disposition of
partnership property subject to one or
more partnership nonrecourse liabilities
and then, if necessary, of a pro rata
portion of the partnership’s other items
of income and gain for that year. A
similar rule applies to chargebacks of
partner nonrecourse debt minimum
gain. See § 1.704–2(i)(4).
Commenters recommended that,
where a minimum gain chargeback
results from the discharge of partnership
or partner nonrecourse debt, the firsttier of the minimum gain chargeback
should include COD income relating to
such debt. The IRS and the Treasury
Department agree with this comment,
and therefore the final regulations
provide that COD income arising from a
discharge of a partnership or partner
nonrecourse indebtedness is treated as a
first-tier item for minimum gain
chargeback purposes under §§ 1.704–
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2(f)(6), 1.704–2(j)(2)(i)(A), and 1.704–
2(j)(2)(ii)(A).
5. Disposition of Installment Obligations
Section 453B provides rules regarding
dispositions of installment obligations.
Generally, if an installment obligation of
a taxpayer is satisfied at other than its
face value or the taxpayer distributes,
transmits, sells, or otherwise disposes of
an installment obligation, the taxpayer
recognizes any deferred gain or loss.
However, § 1.453–9(c)(2) provides that
the contribution of an installment
obligation to a partnership under
section 721, for example, does not
constitute a disposition. The IRS and
the Treasury Department believe that
this exception does not apply to a
creditor who disposes of an installment
obligation of a partnership by
contributing it to the debtor partnership,
even if the transaction qualifies under
section 721. In that case, the creditor
must recognize gain or loss under
section 453B. This treatment is
consistent with the corporate rules that
require a creditor to recognize gain or
loss under section 453B on the
disposition of an installment obligation
of a corporation to the debtor
corporation in a transaction that
qualifies under section 351. Rev. Rul.
73–423 (1973–2 CB 161), (see
§ 601.601(d)(2)(ii)(b)). Accordingly, the
IRS and the Treasury Department are
proposing regulations under section
453B to clarify this issue.
6. Additional Issues
The preamble to the proposed
regulations requested comments on
whether any special allocation rules of
COD income should apply where
partnership indebtedness owed to a
preexisting partner is satisfied with the
transfer of a partnership interest. The
proposed regulations did not address
this issue. Commenters recommended
that the final regulations not impose any
special allocation rules regarding COD
income realized under section 108(e)(8)
from the cancellation of a partnership
indebtedness owed to a preexisting
partner. Commenters suggested that
Rev. Rul. 92–97 (1992–2 CB 124) and
Rev. Rul. 99–43 (1999–2 CB 506), (see
§ 601.601(d)(2)(ii)(b)), provide an
appropriate framework for determining
how COD income should be allocated,
whether or not the creditor is a partner
in the partnership. The IRS and the
Treasury Department agree that existing
guidance provides a framework for
allocating COD income and, thus, the
final regulations do not adopt any
additional guidance regarding the
allocation of COD income among
partners in a debt-for-equity exchange.
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Effective/Applicability Date
These final regulations apply to debtfor-equity exchanges occurring on or
after the date these final regulations are
published in the Federal Register.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and because these
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, the notice
of proposed rulemaking that preceded
these regulations was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business.
Drafting Information
The principal authors of these
regulations are Joseph R. Worst and
Megan A. Stoner of the Office of the
Associate Chief Counsel (Passthroughs
and Special Industries). However, other
personnel from the IRS and the Treasury
Department participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Adoption of Amendment to the
Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:
■
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.108–8 is added to
read as follows:
■
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§ 1.108–8 Indebtedness satisfied by
partnership interest.
(a) In general. For purposes of
determining income of a debtor from
discharge of indebtedness (COD
income), if a debtor partnership
transfers a capital or profits interest in
the partnership to a creditor in
satisfaction of its recourse or
nonrecourse indebtedness (a debt-forequity exchange), the partnership is
treated as having satisfied the
indebtedness with an amount of money
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equal to the fair market value of the
partnership interest.
(b) Determination of fair market
value—(1) In general. All the facts and
circumstances are considered in
determining the fair market value of a
partnership interest transferred by a
debtor partnership to a creditor in
satisfaction of the debtor partnership’s
indebtedness (debt-for-equity interest)
for purposes of paragraph (a) of this
section. If the fair market value of the
debt-for-equity interest does not equal
the fair market value of the
indebtedness exchanged, then general
tax law principles shall apply to
account for the difference.
(2) Safe harbor—(i) General rule. For
purposes of paragraph (a) of this section,
the fair market value of a debt-for-equity
interest is deemed to be equal to the
liquidation value of the debt-for-equity
interest, as defined in paragraph
(b)(2)(iii) of this section, if the following
requirements are satisfied—
(A) The creditor, debtor partnership,
and its partners treat the fair market
value of the indebtedness as being equal
to the liquidation value of the debt-forequity interest for purposes of
determining the tax consequences of the
debt-for-equity exchange;
(B) If, as part of the same overall
transaction, the debtor partnership
transfers more than one debt-for-equity
interest to one or more creditors, then
each creditor, debtor partnership, and
its partners treat the fair market value of
each debt-for-equity interest transferred
by the debtor partnership to such
creditors as equal to its liquidation
value;
(C) The debt-for-equity exchange is a
transaction that has terms that are
comparable to terms that would be
agreed to by unrelated parties
negotiating with adverse interests; and
(D) Subsequent to the debt-for-equity
exchange, the debtor partnership does
not redeem the debt-for-equity interest,
and no person bearing a relationship to
the debtor partnership or its partners
that is specified in section 267(b) or
section 707(b) purchases the debt-forequity interest, as part of a plan at the
time of the debt-for-equity exchange that
has as a principal purpose the
avoidance of COD income by the debtor
partnership.
(ii) Tiered-partnership rule. For
purposes of this paragraph (b)(2), the
liquidation value of a debt-for-equity
interest in a partnership (upper-tier
partnership) that directly or indirectly
owns an interest in one or more
partnerships (lower-tier partnership(s))
is determined by taking into account the
liquidation value of such lower-tier
partnership interests.
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(iii) Definition of liquidation value.
For purposes of this paragraph (b)(2),
the liquidation value of a debt-for-equity
interest equals the amount of cash that
the creditor would receive with respect
to the debt-for-equity interest if,
immediately after the debt-for-equity
exchange, the partnership sold all of its
assets (including goodwill, going
concern value, and any other
intangibles) for cash equal to the fair
market value of those assets and then
liquidated.
(c) Example. The following example
illustrates the provisions of this section:
Example. (i) AB partnership has $1,000 of
outstanding indebtedness owed to C. C agrees
to transfer to AB partnership the $1,000
indebtedness in a debt-for-equity exchange
for a debt-for-equity interest in AB
partnership. The liquidation value of C’s
debt-for-equity interest is $700, which is the
amount of cash that C would receive with
respect to that interest if, immediately after
the debt-for-equity exchange, AB partnership
sold all of its assets for cash equal to the fair
market value of those assets and then
liquidated. Each of the requirements of the
liquidation value safe harbor described in
paragraph (b)(2) of this section is satisfied.
(ii) Because the requirements in paragraph
(b)(2) of this section are satisfied, the fair
market value of C’s debt-for-equity interest in
AB partnership for purposes of determining
AB partnership’s COD income is the
liquidation value of C’s debt-for-equity
interest, or $700. Accordingly, AB
partnership is treated as satisfying the $1,000
indebtedness for $700 under section
108(e)(8).
(d) Effective/applicability date. This
section applies to debt-for-equity
exchanges occurring on or after
November 17, 2011.
■ Par. 3. Section 1.704–2 is amended as
follows:
■ 1. In paragraph (f)(6), the first
sentence is revised and in the last
sentence, the language ‘‘(j)(2)(i) and
(iii)’’ is removed and the language
‘‘(j)(2)(i) and (j)(2)(iii)’’ is added in its
place.
2. Paragraphs (j)(2)(i)(A) and
(j)(2)(ii)(A) are revised.
■
3. In paragraph (l), revise the
paragraph heading and add a new
paragraph (l)(1)(v).
The revisions and additions read as
follows:
■
§ 1.704–2 Allocations attributable to
nonrecourse liabilities.
*
*
*
*
*
(f) * * *
(6) * * * Any minimum gain
chargeback required for a partnership
taxable year consists first of a pro rata
portion of certain gains recognized from
the disposition of partnership property
E:\FR\FM\17NOR1.SGM
17NOR1
Federal Register / Vol. 76, No. 222 / Thursday, November 17, 2011 / Rules and Regulations
subject to one or more partnership
nonrecourse liabilities and income from
the discharge of indebtedness relating to
one or more partnership nonrecourse
liabilities to which partnership property
is subject, and then, if necessary,
consists of a pro rata portion of the
partnership’s other items of income and
gain for that year. * * *
*
*
*
*
*
(j) * * *
(2) * * *
(i) * * *
(A) First, a pro rata portion of gain
from the disposition of property subject
to partnership nonrecourse liabilities
and discharge of indebtedness income
relating to partnership nonrecourse
liabilities to which property is subject;
*
*
*
*
*
(ii) * * *
(A) First, a pro rata portion of gain
from the disposition of property subject
to partner nonrecourse debt and
discharge of indebtedness income
relating to partner nonrecourse debt to
which property is subject.
*
*
*
*
*
(l) Effective/applicability dates. * * *
(1) * * *
(v) The first sentence of paragraph
(f)(6) of this section and paragraphs
(j)(2)(i)(A) and (j)(2)(ii)(A) of this section
apply on and after November 17, 2011.
*
*
*
*
*
■ Par. 4. Section 1.721–1 is amended by
adding new paragraph (d) to read as
follows:
§ 1.721–1 Nonrecognition of gain or loss
on contribution.
pmangrum on DSK3VPTVN1PROD with RULES
*
*
*
*
*
(d) Debt-for-equity exchange—(1) In
general. Except as otherwise provided
in section 721 and the regulations under
section 721, section 721 applies to a
contribution of a partnership’s
indebtedness by a creditor to the debtor
partnership in exchange for a capital or
profits interest in the partnership (debtfor-equity exchange). See § 1.108–8(a)
for rules in determining the debtor
partnership’s discharge of indebtedness
income.
(2) Exception. Section 721 does not
apply to a debt-for-equity exchange to
the extent the transfer of the partnership
interest to the creditor is in exchange for
the partnership’s indebtedness for
unpaid rent, royalties, or interest
(including accrued original issue
discount) that accrued on or after the
beginning of the creditor’s holding
period for the indebtedness. The debtor
partnership will not recognize gain or
loss upon the transfer of a partnership
interest to a creditor in a debt-for-equity
exchange for unpaid rent, royalties, or
VerDate Mar<15>2010
14:30 Nov 16, 2011
Jkt 226001
interest (including accrued original
issue discount).
(3) Cross reference. For rules in
determining whether a partnership
interest transferred to a creditor in a
debt-for-equity exchange is treated as
payment of interest or accrued original
issue discount, see §§ 1.446–2 and
1.1275–2, respectively.
(4) Effective/applicability date. This
paragraph (d) applies to debt-for-equity
exchanges occurring on or after
November 17, 2011.
Steven T. Miller,
Deputy Commissioner for Services and
Enforcement.
Approved: November 8, 2011.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury.
[FR Doc. 2011–29553 Filed 11–15–11; 11:15 am]
BILLING CODE 4830–01–P
DEPARTMENT OF THE TREASURY
26 CFR Part 301
[TD 9554]
Extending Religious and Family
Member FICA and FUTA Exceptions to
Disregarded Entities; Correction
Internal Revenue Service (IRS),
Treasury.
ACTION: Correcting amendment.
AGENCY:
This document describes a
correction to final and temporary
regulations (TD 9554) extending the
exceptions from taxes under the Federal
Insurance Contributions Act (‘‘FICA’’)
and the Federal Unemployment Tax Act
(‘‘FUTA’’) under sections 3121(b)(3)
(concerning individuals who work for
certain family members), 3127
(concerning members of religious
faiths), and 3306(c)(5) (concerning
persons employed by children and
spouses and children under 21
employed by their parents) of the
Internal Revenue Code (‘‘Code’’) to
entities that are disregarded as separate
from their owners for Federal tax
purposes. The temporary regulations
also clarify the existing rule that the
owners of disregarded entities, except
for qualified subchapter S subsidiaries,
are responsible for backup withholding
and related information reporting
requirements under section 3406. These
regulations were published in the
Federal Register on Tuesday, November
1, 2011 (76 FR 67363).
SUMMARY:
Fmt 4700
Background
The final and temporary regulations
that are the subject of this document are
under section 7701 of the Internal
Revenue Code.
Need for Correction
As published, final and temporary
regulations (TD 9554) contain an error
that may prove to be misleading and is
in need of clarification.
List of Subjects in 26 CFR Part 301
Employment taxes, Estate taxes,
Excise taxes, Gift taxes, Income taxes,
Penalties, Reporting and recording
requirements.
PART 301—PROCEDURE AND
ADMINISTRATION
RIN 1545–BJ07
Frm 00019
This correction is effective on
November 17, 2011, and is applicable
on November 1, 2011.
FOR FURTHER INFORMATION CONTACT:
Joseph Perera, (202) 622–6040 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
DATES:
Correction of Publication
Accordingly, 26 CFR part 301 is
corrected by making the following
correcting amendment:
Internal Revenue Service
PO 00000
71259
Sfmt 4700
Paragraph 1. The authority citation
for part 301 continues to read in part as
follows:
■
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 301.7701–2T is added
to read as follows:
■
§ 301.7701–2T Business entities;
definitions (temporary).
(a) through (c)(2)(iv) [Reserved]. For
further guidance, see § 301.7701–2(a)
through (c)(2)(iv).
(A) In general. Section § 301.7701–
2(c)(2)(i) (relating to certain wholly
owned entities) does not apply to taxes
imposed under Subtitle C—Employment
Taxes and Collection of Income Tax
(chapters 21, 22, 23, 23A, 24 and 25 of
the Internal Revenue Code). However,
§ 301.7701–2(c)(2)(i) does apply to
withholding requirements imposed
under section 3406 (backup
withholding). The owner of a business
entity that is disregarded under
§ 301.7701–2 is subject to the
withholding requirements imposed
under section 3406 (backup
withholding). Section 301.7701–
2(c)(2)(i) also applies to taxes imposed
under Subtitle A, including Chapter 2—
Tax on Self Employment Income. The
owner of an entity that is treated in the
same manner as a sole proprietorship
under § 301.7701–2(a) will be subject to
tax on self-employment income.
E:\FR\FM\17NOR1.SGM
17NOR1
]]>Agencies
[Federal Register Volume 76, Number 222 (Thursday, November 17, 2011)]
[Rules and Regulations]
[Pages 71255-71259]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-29553]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9557]
RIN 1545-BF27
Application of Section 108(e)(8) to Indebtedness Satisfied by a
Partnership Interest
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations relating to the
application of section 108(e)(8) of the Internal Revenue Code (Code) to
partnerships and their partners. These regulations provide guidance
regarding the determination of discharge of indebtedness income of a
partnership that transfers a partnership interest to a creditor in
satisfaction of the partnership's indebtedness. The final regulations
also address the application of section 721 to a contribution of a
partnership's recourse or nonrecourse indebtedness by a creditor to the
partnership in exchange for a capital or profits interest in the
partnership. Moreover, the final regulations address how a
partnership's discharge of indebtedness income is allocated as a
minimum gain chargeback under section 704. The regulations affect
partnerships and their partners.
DATES: Effective Date: These regulations are effective on November 17,
2011.
Applicability Date: For dates of applicability, see Sec. Sec.
1.108-8(d), 1.704-2(l)(1)(v), and 1.721-1(d)(4).
FOR FURTHER INFORMATION CONTACT: Joseph R. Worst or Megan A. Stoner,
Office of Associate Chief Counsel (Passthroughs and Special
Industries), (202) 622-3070 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to 26 CFR part 1 under sections
108, 704, and 721 of the Code relating to the application of section
108(e)(8) to partnerships.
Section 108(e)(8) was amended by section 896 of the American Jobs
Creation Act of 2004, Public Law 108-357 (118 Stat. 1648), to include
discharges of partnership indebtedness occurring on or after October
22, 2004. Prior to the amendment, section 108(e)(8) only applied to
discharges of corporate indebtedness. Section 108(e)(8), as amended,
provides that, for purposes of determining income of a debtor from
discharge of indebtedness (COD income), if a debtor corporation
transfers stock or a debtor partnership transfers a capital or profits
interest in such partnership to a creditor in satisfaction of its
recourse or nonrecourse indebtedness, such corporation or partnership
shall be treated as having satisfied the indebtedness with an amount of
money equal to the fair market value of the stock or interest. In the
case of a partnership, any COD income recognized under section
108(e)(8) shall be included in the distributive shares of the partners
in the partnership immediately before such discharge.
A notice of proposed rulemaking and a notice of public hearing
(REG-164370-05, 2008-46 IRB 1157) were published in the Federal
Register (73 FR 64903) on October 31, 2008, proposing amendments to the
regulations regarding the application of section 108(e)(8) to
partnerships and their partners, including the determination of COD
income of a partnership that transfers a partnership interest to a
creditor in satisfaction of the partnership's indebtedness (debt-for-
equity exchange). The proposed regulations also provide that section
721 generally applies to a contribution of a partnership's recourse or
nonrecourse indebtedness by a creditor to the partnership in exchange
for a capital or profits interest in the partnership. A public hearing
on the proposed regulations was scheduled for February 19, 2009, but
was cancelled because no one requested to speak. However, comments
responding to the proposed regulations were received. After
consideration of these comments, the proposed regulations are adopted
as revised by this Treasury decision. These final regulations generally
retain the provisions of the proposed regulations with the
modifications discussed in the preamble.
Summary of Comments and Explanation of Provisions
1. Valuation of Partnership Interest Transferred in Satisfaction of
Partnership Indebtedness
Section 108(e)(8) provides that, for purposes of determining COD
income of a debtor partnership, the partnership shall be treated as
having satisfied the indebtedness with an amount of money equal to the
fair market value of the interest transferred to the creditor.
Generally, the amount by which the indebtedness exceeds the fair market
value of the partnership interest transferred is the amount of COD
income required to be included in the distributive shares of the
partners that were partners in the debtor partnership immediately
before the discharge.
The proposed regulations provide that, for purposes of determining
the amount of COD income, the fair market value of the partnership
interest transferred to the creditor in a debt-for-equity exchange
(debt-for-equity interest) is the liquidation value of the partnership
interest if four requirements are satisfied (liquidation value safe
harbor). For this purpose, liquidation value equals the amount of cash
that the creditor would receive with respect to the debt-for-equity
interest if, immediately after the transfer, the partnership sold all
of its assets (including goodwill, going concern value, and any other
intangibles) for cash equal to the fair market value of those assets,
and then liquidated.
The four conditions of the liquidation value safe harbor in the
proposed regulations are that (i) The debtor partnership determines and
maintains capital accounts of its partners in accordance with the
capital accounting rules of Sec. 1.704-1(b)(2)(iv) (capital account
maintenance requirement); (ii) the creditor, debtor partnership, and
its partners treat the fair market value of
[[Page 71256]]
the indebtedness as being equal to the liquidation value of the debt-
for-equity interest for purposes of determining the tax consequences of
the debt-for-equity exchange (consistency requirement); (iii) the debt-
for-equity exchange is an arm's-length transaction (arm's-length
requirement); and (iv) subsequent to the debt-for-equity exchange,
neither the partnership redeems nor any person related to the
partnership purchases the debt-for-equity interest as part of a plan at
the time of the debt-for-equity exchange which has as a principal
purpose the avoidance of COD income by the partnership (anti-abuse
provision). If these requirements are not satisfied, all of the facts
and circumstances are considered in determining the fair market value
of the debt-for-equity interest for purposes of applying section
108(e)(8). Each of the four requirements of the proposed regulations is
discussed in the preamble.
The first requirement is the capital account maintenance
requirement. Commenters requested that the final regulations clarify
that this requirement does not necessitate compliance with all aspects
of the substantial economic effect safe harbor under Sec. 1.704-
1(b)(2), notably the requirement that the partnership liquidate in
accordance with the positive capital account balances of its partners.
To eliminate confusion over the capital account maintenance requirement
in the liquidation value safe harbor, the IRS and the Treasury
Department have decided to remove the capital account maintenance
requirement from the liquidation value safe harbor because the
maintenance of capital accounts is not necessary to the determination
of the liquidation value of the partner's interest.
The second requirement of the liquidation value safe harbor in the
proposed regulations is the consistency requirement. This requirement
is intended to ensure consistent reporting by the creditor, debtor
partnership, and its partners. One commenter suggested narrowing the
scope of this requirement in the final regulations so that the failure
of a partner to consistently treat the fair market value of the
indebtedness as being equal to the liquidation value of the debt-for-
equity interest does not invalidate the partnership's use of the
liquidation value safe harbor, provided the creditor and the
partnership otherwise consistently determine and report COD income
based on such valuation. The IRS and the Treasury Department considered
the issue and decided to not modify this requirement in the final
regulations. The amount of COD income computed under the liquidation
value safe harbor may differ from the amount computed using the fair
market value of the partnership interest. Thus, in order for the
partnership to use the liquidation value safe harbor, the IRS and the
Treasury Department believe that the partnership and all of its
partners must report consistently.
One commenter suggested that taxpayers should not be able to
selectively exploit to their benefit the discrepancy between
liquidation value and fair market value and suggested that the final
regulations require that a partnership apply a consistent valuation
methodology to all equity issued in any debt-for-equity exchange that
is part of the same overall transaction. The IRS and the Treasury
Department agree, and therefore the final regulations add this as a
condition to the liquidation value safe harbor.
The third requirement of the liquidation value safe harbor in the
proposed regulations is the arm's-length requirement. Commenters
requested that the final regulations clarify whether this requirement
can be satisfied where the exchange is between the partnership and an
existing partner. The IRS and the Treasury Department believe that the
liquidation value safe harbor should be available where the transaction
involves related parties and have clarified this requirement in the
final regulations to provide that, as long as the debt-for-equity
exchange has terms that are comparable to terms that would be agreed to
by unrelated parties negotiating with adverse interests, the third
requirement is satisfied even if the transaction is between related
parties.
The fourth requirement of the liquidation value safe harbor in the
proposed regulations is an anti-abuse provision. The final regulations
follow the anti-abuse provision of the proposed regulations by adding a
restriction on subsequent purchases of the debt-for-equity interest by
a person related to any partner (in addition to purchases by a person
related to the partnership) as part of a tax-avoidance plan. Thus,
under the final regulations, the partnership cannot redeem and no
person related to the partnership or to any partner can purchase the
debt-for-equity interest as part of a plan at the time of the debt-for-
equity exchange that has as a principal purpose the avoidance of COD
income by the partnership. Commenters requested that the final
regulations clarify the meaning of ``related'' in this context. The IRS
and the Treasury Department agree that clarification is warranted and
therefore the final regulations refer to sections 267(b) and 707(b) for
the meaning of ``related'' in the anti-abuse provision.
The final regulations also address the application of the
liquidation value safe harbor rule to a partnership (upper-tier
partnership) that directly or indirectly owns an interest in one or
more partnerships (lower-tier partnership(s)). The final regulations
provide that, with respect to interests held in one or more lower-tier
partnerships, the liquidation value of an interest in an upper-tier
partnership is determined by taking into account the liquidation value
of such lower-tier partnership interest.
The final regulations provide that if the fair market value of the
debt-for-equity interest does not equal the fair market value of the
indebtedness exchanged, then general tax law principles shall apply to
account for the difference. Moreover, section 707(a)(2)(A), as it
relates to the treatment of payments to partners for transfers of
property, will be considered, if appropriate.
2. Application of Section 721 to Debt-for-Equity Exchanges
The proposed regulations generally provide that the nonrecognition
rule of section 721 applies to the debt-for-equity exchange. Under the
proposed regulations, the creditor does not recognize a loss or a bad
debt deduction in the debt-for-equity exchange. The creditor's basis in
the debt-for-equity interest is increased under section 722 by the
adjusted basis of the indebtedness. The preamble to the proposed
regulations requested comments on alternative approaches.
A number of commenters agreed with the general application of
section 721 to the debt-for-equity exchange, but recommended that the
rule be modified in the final regulations. The commenters argued that
the application of section 721 to the debt-for-equity exchange may
result in asymmetry in the timing of the partnership's COD income
inclusion and the creditor's loss, character conversion for the
creditor from ordinary loss to capital loss, and disparities between
the partners' aggregate bases in their partnership interests and the
partnership's basis in its assets. Some commenters suggested that these
results could be alleviated if the final regulations bifurcate the
debt-for-equity exchange into two transactions, namely the cancellation
of a portion of the indebtedness, and the contribution of the balance
in exchange for an interest in the partnership in a transaction to
which section 721 applies (bifurcation approach). Another commenter,
however, stated that a
[[Page 71257]]
bifurcation approach is not consistent with section 721 or case law.
The IRS and the Treasury Department agree with the latter comment
and believe that the bifurcation approach would be inconsistent with
the treatment of analogous corporate debt-for-equity transactions
involving corporate indebtedness evidenced by a security in which
section 351 would apply, for example. Further, comments in favor of the
bifurcation approach assume a creditor has not validly taken a bad debt
deduction under section 166 prior to the debt-for-equity exchange in a
transaction independent of and separate from the debt-for-equity
exchange. After consideration of the issue, the IRS and the Treasury
Department have determined that the final regulations will not adopt
the bifurcation approach.
3. Obligations for Unpaid Rent, Royalties, and Interest
The proposed regulations provide that section 721 does not apply to
the transfer of a partnership interest to a creditor in satisfaction of
a partnership's recourse or nonrecourse indebtedness for unpaid rent,
royalties, or interest on indebtedness (including accrued original
issue discount). These items generally give rise to ordinary income to
the creditor and a deduction to the partnership. Most commenters agreed
that the general nonrecognition rule under section 721 should not apply
to the transfer of a partnership interest in satisfaction of these
items. The IRS and the Treasury Department believe that the exception
to section 721 for these items is necessary to prevent the conversion
of ordinary income into capital gain.
The final regulations retain the exception for these ordinary
income items, but, in response to a comment, limit the scope of the
exception. The commenter suggested that the exception be limited to
items that accrued on or after the beginning of the creditor's holding
period for the indebtedness. The IRS and the Treasury Department agree
with the comment, and therefore, the final regulations provide that
section 721 does not apply to a debt-for-equity exchange to the extent
the partnership interest is exchanged for the partnership's
indebtedness for unpaid rent, royalties, or interest on the
partnership's indebtedness (including accrued original issue discount)
that accrued on or after the beginning of the creditor's holding period
for the indebtedness.
The preamble to the proposed regulations states the general rule
that when property is transferred as payment on indebtedness (or in
satisfaction thereof), gain or loss on the property is recognized.
Under that approach, in a debt-for-equity exchange, if the partnership
is treated as satisfying its indebtedness for unpaid rent, royalties,
or interest on indebtedness (including accrued original issue discount)
with a fractional interest in each asset of the partnership, the
partnership could recognize gain or loss equal to the difference
between the fair market value of each partial asset deemed transferred
to the creditor and the adjusted basis in that partial asset. The IRS
and the Treasury Department believe that in a debt-for-equity exchange
where the partnership has not disposed of any of its assets, the
partnership should not be required to recognize gain or loss on the
transfer of a partnership interest in satisfaction of its indebtedness
for unpaid rent, royalties, or interest. Therefore, under the final
regulations, a debtor partnership will not recognize gain or loss upon
the transfer of a partnership interest to a creditor in a debt-for-
equity exchange for unpaid rent, royalties, or interest that accrued on
or after the beginning of the creditor's holding period for the
indebtedness.
4. COD Income as First-Tier Item for Minimum Gain Chargeback Rules
The preamble to the proposed regulations requested comments
regarding the manner in which COD income arising from a debt-for-equity
exchange should be treated for purposes of the minimum gain chargeback
rules under Sec. 1.704-2(f)(6). Section 1.704-2(f)(6) provides that
any minimum gain chargeback required for a partnership taxable year
consists first of certain gains recognized from the disposition of
partnership property subject to one or more partnership nonrecourse
liabilities and then, if necessary, of a pro rata portion of the
partnership's other items of income and gain for that year. A similar
rule applies to chargebacks of partner nonrecourse debt minimum gain.
See Sec. 1.704-2(i)(4).
Commenters recommended that, where a minimum gain chargeback
results from the discharge of partnership or partner nonrecourse debt,
the first-tier of the minimum gain chargeback should include COD income
relating to such debt. The IRS and the Treasury Department agree with
this comment, and therefore the final regulations provide that COD
income arising from a discharge of a partnership or partner nonrecourse
indebtedness is treated as a first-tier item for minimum gain
chargeback purposes under Sec. Sec. 1.704-2(f)(6), 1.704-
2(j)(2)(i)(A), and 1.704-2(j)(2)(ii)(A).
5. Disposition of Installment Obligations
Section 453B provides rules regarding dispositions of installment
obligations. Generally, if an installment obligation of a taxpayer is
satisfied at other than its face value or the taxpayer distributes,
transmits, sells, or otherwise disposes of an installment obligation,
the taxpayer recognizes any deferred gain or loss. However, Sec.
1.453-9(c)(2) provides that the contribution of an installment
obligation to a partnership under section 721, for example, does not
constitute a disposition. The IRS and the Treasury Department believe
that this exception does not apply to a creditor who disposes of an
installment obligation of a partnership by contributing it to the
debtor partnership, even if the transaction qualifies under section
721. In that case, the creditor must recognize gain or loss under
section 453B. This treatment is consistent with the corporate rules
that require a creditor to recognize gain or loss under section 453B on
the disposition of an installment obligation of a corporation to the
debtor corporation in a transaction that qualifies under section 351.
Rev. Rul. 73-423 (1973-2 CB 161), (see Sec. 601.601(d)(2)(ii)(b)).
Accordingly, the IRS and the Treasury Department are proposing
regulations under section 453B to clarify this issue.
6. Additional Issues
The preamble to the proposed regulations requested comments on
whether any special allocation rules of COD income should apply where
partnership indebtedness owed to a preexisting partner is satisfied
with the transfer of a partnership interest. The proposed regulations
did not address this issue. Commenters recommended that the final
regulations not impose any special allocation rules regarding COD
income realized under section 108(e)(8) from the cancellation of a
partnership indebtedness owed to a preexisting partner. Commenters
suggested that Rev. Rul. 92-97 (1992-2 CB 124) and Rev. Rul. 99-43
(1999-2 CB 506), (see Sec. 601.601(d)(2)(ii)(b)), provide an
appropriate framework for determining how COD income should be
allocated, whether or not the creditor is a partner in the partnership.
The IRS and the Treasury Department agree that existing guidance
provides a framework for allocating COD income and, thus, the final
regulations do not adopt any additional guidance regarding the
allocation of COD income among partners in a debt-for-equity exchange.
[[Page 71258]]
Effective/Applicability Date
These final regulations apply to debt-for-equity exchanges
occurring on or after the date these final regulations are published in
the Federal Register.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because
these regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking that preceded these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting Information
The principal authors of these regulations are Joseph R. Worst and
Megan A. Stoner of the Office of the Associate Chief Counsel
(Passthroughs and Special Industries). However, other personnel from
the IRS and the Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendment to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.108-8 is added to read as follows:
Sec. 1.108-8 Indebtedness satisfied by partnership interest.
(a) In general. For purposes of determining income of a debtor from
discharge of indebtedness (COD income), if a debtor partnership
transfers a capital or profits interest in the partnership to a
creditor in satisfaction of its recourse or nonrecourse indebtedness (a
debt-for-equity exchange), the partnership is treated as having
satisfied the indebtedness with an amount of money equal to the fair
market value of the partnership interest.
(b) Determination of fair market value--(1) In general. All the
facts and circumstances are considered in determining the fair market
value of a partnership interest transferred by a debtor partnership to
a creditor in satisfaction of the debtor partnership's indebtedness
(debt-for-equity interest) for purposes of paragraph (a) of this
section. If the fair market value of the debt-for-equity interest does
not equal the fair market value of the indebtedness exchanged, then
general tax law principles shall apply to account for the difference.
(2) Safe harbor--(i) General rule. For purposes of paragraph (a) of
this section, the fair market value of a debt-for-equity interest is
deemed to be equal to the liquidation value of the debt-for-equity
interest, as defined in paragraph (b)(2)(iii) of this section, if the
following requirements are satisfied--
(A) The creditor, debtor partnership, and its partners treat the
fair market value of the indebtedness as being equal to the liquidation
value of the debt-for-equity interest for purposes of determining the
tax consequences of the debt-for-equity exchange;
(B) If, as part of the same overall transaction, the debtor
partnership transfers more than one debt-for-equity interest to one or
more creditors, then each creditor, debtor partnership, and its
partners treat the fair market value of each debt-for-equity interest
transferred by the debtor partnership to such creditors as equal to its
liquidation value;
(C) The debt-for-equity exchange is a transaction that has terms
that are comparable to terms that would be agreed to by unrelated
parties negotiating with adverse interests; and
(D) Subsequent to the debt-for-equity exchange, the debtor
partnership does not redeem the debt-for-equity interest, and no person
bearing a relationship to the debtor partnership or its partners that
is specified in section 267(b) or section 707(b) purchases the debt-
for-equity interest, as part of a plan at the time of the debt-for-
equity exchange that has as a principal purpose the avoidance of COD
income by the debtor partnership.
(ii) Tiered-partnership rule. For purposes of this paragraph
(b)(2), the liquidation value of a debt-for-equity interest in a
partnership (upper-tier partnership) that directly or indirectly owns
an interest in one or more partnerships (lower-tier partnership(s)) is
determined by taking into account the liquidation value of such lower-
tier partnership interests.
(iii) Definition of liquidation value. For purposes of this
paragraph (b)(2), the liquidation value of a debt-for-equity interest
equals the amount of cash that the creditor would receive with respect
to the debt-for-equity interest if, immediately after the debt-for-
equity exchange, the partnership sold all of its assets (including
goodwill, going concern value, and any other intangibles) for cash
equal to the fair market value of those assets and then liquidated.
(c) Example. The following example illustrates the provisions of
this section:
Example. (i) AB partnership has $1,000 of outstanding
indebtedness owed to C. C agrees to transfer to AB partnership the
$1,000 indebtedness in a debt-for-equity exchange for a debt-for-
equity interest in AB partnership. The liquidation value of C's
debt-for-equity interest is $700, which is the amount of cash that C
would receive with respect to that interest if, immediately after
the debt-for-equity exchange, AB partnership sold all of its assets
for cash equal to the fair market value of those assets and then
liquidated. Each of the requirements of the liquidation value safe
harbor described in paragraph (b)(2) of this section is satisfied.
(ii) Because the requirements in paragraph (b)(2) of this
section are satisfied, the fair market value of C's debt-for-equity
interest in AB partnership for purposes of determining AB
partnership's COD income is the liquidation value of C's debt-for-
equity interest, or $700. Accordingly, AB partnership is treated as
satisfying the $1,000 indebtedness for $700 under section 108(e)(8).
(d) Effective/applicability date. This section applies to debt-for-
equity exchanges occurring on or after November 17, 2011.
0
Par. 3. Section 1.704-2 is amended as follows:
0
1. In paragraph (f)(6), the first sentence is revised and in the last
sentence, the language ``(j)(2)(i) and (iii)'' is removed and the
language ``(j)(2)(i) and (j)(2)(iii)'' is added in its place.
0
2. Paragraphs (j)(2)(i)(A) and (j)(2)(ii)(A) are revised.
0
3. In paragraph (l), revise the paragraph heading and add a new
paragraph (l)(1)(v).
The revisions and additions read as follows:
Sec. 1.704-2 Allocations attributable to nonrecourse liabilities.
* * * * *
(f) * * *
(6) * * * Any minimum gain chargeback required for a partnership
taxable year consists first of a pro rata portion of certain gains
recognized from the disposition of partnership property
[[Page 71259]]
subject to one or more partnership nonrecourse liabilities and income
from the discharge of indebtedness relating to one or more partnership
nonrecourse liabilities to which partnership property is subject, and
then, if necessary, consists of a pro rata portion of the partnership's
other items of income and gain for that year. * * *
* * * * *
(j) * * *
(2) * * *
(i) * * *
(A) First, a pro rata portion of gain from the disposition of
property subject to partnership nonrecourse liabilities and discharge
of indebtedness income relating to partnership nonrecourse liabilities
to which property is subject;
* * * * *
(ii) * * *
(A) First, a pro rata portion of gain from the disposition of
property subject to partner nonrecourse debt and discharge of
indebtedness income relating to partner nonrecourse debt to which
property is subject.
* * * * *
(l) Effective/applicability dates. * * *
(1) * * *
(v) The first sentence of paragraph (f)(6) of this section and
paragraphs (j)(2)(i)(A) and (j)(2)(ii)(A) of this section apply on and
after November 17, 2011.
* * * * *
0
Par. 4. Section 1.721-1 is amended by adding new paragraph (d) to read
as follows:
Sec. 1.721-1 Nonrecognition of gain or loss on contribution.
* * * * *
(d) Debt-for-equity exchange--(1) In general. Except as otherwise
provided in section 721 and the regulations under section 721, section
721 applies to a contribution of a partnership's indebtedness by a
creditor to the debtor partnership in exchange for a capital or profits
interest in the partnership (debt-for-equity exchange). See Sec.
1.108-8(a) for rules in determining the debtor partnership's discharge
of indebtedness income.
(2) Exception. Section 721 does not apply to a debt-for-equity
exchange to the extent the transfer of the partnership interest to the
creditor is in exchange for the partnership's indebtedness for unpaid
rent, royalties, or interest (including accrued original issue
discount) that accrued on or after the beginning of the creditor's
holding period for the indebtedness. The debtor partnership will not
recognize gain or loss upon the transfer of a partnership interest to a
creditor in a debt-for-equity exchange for unpaid rent, royalties, or
interest (including accrued original issue discount).
(3) Cross reference. For rules in determining whether a partnership
interest transferred to a creditor in a debt-for-equity exchange is
treated as payment of interest or accrued original issue discount, see
Sec. Sec. 1.446-2 and 1.1275-2, respectively.
(4) Effective/applicability date. This paragraph (d) applies to
debt-for-equity exchanges occurring on or after November 17, 2011.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
Approved: November 8, 2011.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury.
[FR Doc. 2011-29553 Filed 11-15-11; 11:15 am]
BILLING CODE 4830-01-P
