Rev. Rul. 76-86

Rev. Rul. 76-86

Advice has been requested concerning whether certain inventory purchased on open accounts is "property used in a trade or business" for purposes of section 108 of the Internal Revenue Code of 1954, under the circumstances described below.

The taxpayer is a sole proprietorship that uses the accrual method of accounting. In the years 1972 and 1973, the taxpayer purchased merchandise for resale. In 1975 liabilities amounting to at least $40,000 remained unpaid as the result of the aforementioned purchases of inventory.

In June 1975 the seller of the merchandise offered to settle the unpaid liabilities in exchange for a payment of $10,000. This offer was accepted in a timely manner by the taxpayer; and upon the payment of the $10,000, the seller cancelled the balance of the debt.

Section 108(a) of the Code provides, in part, that an individual taxpayer may elect to exclude income arising from a discharge of indebtedness when the indebtedness was incurred in connection with the purchase of property used in the taxpayer's trade or business.

Section 1.1017-1 of the Income Tax Regulations provides, in part, that an adjustment with respect to the taxpayer's basis in property shall be made in any case in which there shall have been an exclusion from gross income under section 108(a) of the Code on account of discharge of indebtedness during the taxable year.

Congress restricted the use of section 108 by an individual to indebtedness incurred in connection with property used in a trade or business in order to exclude cases of personal indebtedness from the applicability of section 108. There is no necessity to give the phrase property used in a trade or business anything but its literal meaning in order to effectuate the intent of Congress. Thus, neither section 108 of the Code nor the regulations thereunder limit the scope of the phrase property used in a trade or business so as to exclude therefrom property in the nature of inventory.

Accordingly, for purposes of section 108(a)(1)(B) of the Code, the inventory in the instant case will be considered property used in a trade or business.

In order to take advantage of the exclusion from gross income provided by section 108(a), a taxpayer must file a timely consent to an appropriate adjustment of a basis pursuant to section 1017 of the Code and the regulations thereunder.