[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1001-2]
[Page 15-17]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.1001-2 Discharge of liabilities.
(a) Inclusion in amount realized--(1) In general. Except as provided
in paragraph (a) (2) and (3) of this section, the amount realized from a
sale or other disposition of property includes the amount of liabilities
from which the transferor is discharged as a result of the sale or
disposition.
(2) Discharge of indebtedness. The amount realized on a sale or
other disposition of property that secures a recourse liability does not
include amounts that are (or would be if realized and recognized) income
from the discharge of indebtedness under section 61(a)(12). For
situations where amounts arising from the discharge of indebtedness are
not realized and recognized, see section 108 and Sec. 1.61-12(b)(1).
(3) Liability incurred on acquisition. In the case of a liability
incurred by reason of the acquisition of the property, this section does
not apply to the extent that such liability was not taken into account
in determining the transferor's basis for such property.
(4) Special rules. For purposes of this section--
(i) The sale or other disposition of property that secures a
nonrecourse liability discharges the transferor from the liability;
(ii) The sale or other disposition of property that secures a
recourse liability discharges the transferor from the liability if
another person agrees to pay the liability (whether or not the
transferor is in fact released from liability);
(iii) A disposition of property includes a gift of the property or a
transfer of the property in satisfaction of liabilities to which it is
subject;
(iv) Contributions and distributions of property between a partner
and a partnership are not sales or other dispositions of property; and
(v) The liabilities from which a transferor is discharged as a
result of the sale or disposition of a partnership interest include the
transferor's share of the liabilities of the partnership.
(b) Effect of fair market value of security. The fair market value
of the security at the time of sale or disposition is not relevant for
purposes of determining under paragraph (a) of this section the amount
of liabilities from which the taxpayer is discharged or treated as
discharged. Thus, the fact that the fair market value of the property is
less than the amount of the liabilities it secures does not prevent the
full amount of those liabilities from being treated as money received
from the sale or other disposition of the property. However, see
paragraph (a)(2) of this section for a rule relating to certain income
from discharge of indebtedness.
(c) Examples. The provisions of this section may be illustrated by
the following examples. In each example assume the taxpayer uses the
cash receipts and disbursements method of accounting, makes a return on
the basis of the calendar year, and sells or disposes of all property
which is security for a given liability.
Example 1. In 1976 A purchases an asset for $10,000. A pays the
seller $1,000 in cash and signs a note payable to the seller for $9,000.
A is personally liable for repayment with the seller having full
recourse in the event of default. In addition, the asset which was
purchased is pledged as security. During the years 1976 and 1977, A
takes depreciation deductions on the asset in the amount of $3,100.
During this same time period A reduces the outstanding principal on the
note to $7,600. At the beginning of 1978 A sells the asset. The buyer
pays A $1,600 in cash and assumes
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personal liability for the $7,600 outstanding liability. A becomes
secondarily liable for repayment of the liability. A's amount realized
is $9,200 ($1,600 + $7,600). Since A's adjusted basis in the asset is
$6,900 ($10,000 - $3,100) A realizes a gain of $2,300 ($9,200 - $6,900).
Example 2. Assume the same facts as in example (1) except that A is
not personally liable on the $9,000 note given to the seller and in the
event of default the seller's only recourse is to the asset. In
addition, on the sale of the asset by A, the purchaser takes the asset
subject to the liability. Nevertheless, A's amount realized is $9,200
and A's gain realized is $2,300 on the sale.
Example 3. In 1975 L becomes a limited partner in partnership GL. L
contributes $10,000 in cash to GL and L's distributive share of
partnership income and loss is 10 percent. L is not entitled to receive
any guaranteed payments. In 1978 M purchases L's entire interest in
partnership GL. At the time of the sale L's adjusted basis in the
partnership interest is $20,000. At that time L's proportionate share of
liabilities, of which no partner has assumed personal liability, is
$15,000. M pays $10,000 in cash for L's interest in the partnership.
Under section 752(d) and this section, L's share of partnership
liabilities, $15,000, is treated as money received. Accordingly, L's
amount realized on the sale of the partnership interest is $25,000
($10,000 + $15,000). L's gain realized on the sale is $5,000 ($25,000 -
$20,000).
Example 4. In 1976 B becomes a limited partner in partnership BG. In
1978 B contributes B's entire interest in BG to a charitable
organization described in section 170(c). At the time of the
contribution all of the partnership liabilities are liabilities for
which neither B nor G has assumed any personal liability and B's
proportionate share of which is $9,000. The charitable organization does
not pay any cash or other property to B, but takes the partnership
interest subject to the $9,000 of liabilities. Assume that the
contribution is treated as a bargain sale to a charitable organization
and that under section 1011(b) $3,000 is determined to be the portion of
B's basis in the partnership interest allocable to the sale. Under
section 752(d) and this section, the $9,000 of liabilities is treated by
B as money received, thereby making B's amount realized $9,000. B's gain
realized is $6,000 ($9,000 - $3,000).
Example 5. In 1975 C, an individual, creates T, an irrevocable
trust. Due to certain powers expressly retained by C, T is a ``grantor
trust'' for purposes of subpart E of part 1 of subchapter J of the code
and therefore C is treated as the owner of the entire trust. T purchases
an interest in P, a partnership. C, as owner of T, deducts the
distributive share of partnership losses attributable to the partnership
interest held by T. In 1978, when the adjusted basis of the partnership
interest held by T is $1,200, C renounces the powers previously and
expressly retained that initially resulted in T being classified as a
grantor trust. Consequently, T ceases to be a grantor trust and C is no
longer considered to be the owner of the trust. At the time of the
renunciation all of P's liabilities are liabilities on which none of the
partners have assumed any personal liability and the proportionate share
of which of the interest held by T is $11,000. Since prior to the
renunciation C was the owner of the entire trust, C was considered the
owner of all the trust property for Federal income tax purposes,
including the partnership interest. Since C was considered to be the
owner of the partnership interest, C not T, was considered to be the
partner in P during the time T was a ``grantor trust''. However, at the
time C renounced the powers that gave rise to T's classification as a
grantor trust, T no longer qualified as a grantor trust with the result
that C was no longer considered to be the owner of the trust and trust
property for Federal income tax purposes. Consequently, at that time, C
is considered to have transferred ownership of the interest in P to T,
now a separate taxable entity, independent of its grantor C. On the
transfer, C's share of partnership liabilities ($11,000) is treated as
money received. Accordingly, C's amount realized is $11,000 and C's gain
realized is $9,800 ($11,000 - $1,200).
Example 6. In 1977 D purchases an asset for $7,500. D pays the
seller $1,500 in cash and signs a note payable to the seller for $6,000.
D is not personally liable for repayment but pledges as security the
newly purchased asset. In the event of default, the seller's only
recourse is to the asset. During the years 1977 and 1978 D takes
depreciation deductions on the asset totaling $4,200 thereby reducing
D's basis in the asset to $3,300 ($7,500 - $4,200). In 1979 D transfers
the asset to a trust which is not a ``grantor trust'' for purposes of
subpart E of part 1 of subchapter J of the Code. Therefore D is not
treated as the owner of the trust. The trust takes the asset subject to
the liability and in addition pays D $750 in cash. Prior to the transfer
D had reduced the amount outstanding on the liability to $4,700. D's
amount realized on the transfer is $5,450 ($4,700 + $750). Since D's
adjusted basis is $3,300, D's gain realized is $2,150 ($5,450 - $3,300).
Example 7. In 1974 E purchases a herd of cattle for breeding
purposes. The purchase price is $20,000 consisting of $1,000 cash and a
$19,000 note. E is not personally liable for repayment of the liability
and the seller's only recourse in the event of default is to the herd of
cattle. In 1977 E transfers the herd back to the original seller thereby
satisfying the indebtedness pursuant to a provision in the original
sales agreement. At the time of the transfer the fair market value of
the herd is $15,000 and the remaining principal balance
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on the note is $19,000. At that time E's adjusted basis in the herd is
$16,500 due to a deductible loss incurred when a portion of the herd
died as a result of disease. As a result of the indebtedness being
satisfied, E's amount realized is $19,000 notwithstanding the fact that
the fair market value of the herd was less than $19,000. E's realized
gain is $2,500 ($19,000 - $16,500).
Example 8. In 1980, F transfers to a creditor an asset with a fair
market value of $6,000 and the creditor discharges $7,500 of
indebtedness for which F is personally liable. The amount realized on
the disposition of the asset is its fair market value ($6,000). In
addition, F has income from the discharge of indebtedness of $1,500
($7,500 - $6,000).
[T.D. 7741, 45 FR 81744, Dec. 12, 1980]