CONDITIONS SET FORTH WHERE IRS WILL ISSUE ADVANCE RULING ON OR PERMIT VARIATION OF ADJUSTMENT TO BASIS OF DEPRECIABLE PROPERTY RESULTING FROM DEBT DISCHARGE

Rev. Proc. 85-44

SECTION 1. PURPOSE

Rev. Proc. 78-16, 1978-2 C.B. 489, sets forth the procedure to be followed by a taxpayer who has requested an advance ruling seeking a variation from the general rule of section 1.1017-1 of the Income Tax Regulations, relating to the adjustment to basis of depreciable property resulting from a discharge of indebtedness, and who desires to enter into a closing agreement pursuant to section 1.1017-2(b) because the taxpayer has a substantial number of depreciable properties. The purpose of this revenue procedure is to modify and update Rev. Proc. 78-16 in light of amendments to sections 108 and 1017 of the Internal Revenue Code by the Bankruptcy Tax Act of 1980 (P.L. 96-589), 1980-2 C.B. 607, and the addition of section 168 to the Code by the Economic Recovery Tax Act of 1981 (P.L. 97-34), 1981-2 C.B. 256.

SEC. 2. BACKGROUND

Section 108(a)(1)(C) of the Code provides that gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if the indebtedness discharged is qualified business indebtedness. In addition, section 108(d)(4) provides that the indebtedness of the taxpayer shall be treated as qualified business indebtedness if (and only if) the indebtedness was incurred or assumed by a corporation, or an individual in connection with property used in his trade or business and such taxpayer makes an election with respect to such indebtedness. Section 1017(b)(3)(A), read in conjunction with section 1017(a), provides that when qualified business indebtedness is discharged the basis adjustment is only to be applied to reduce the basis of any depreciable property held by the taxpayer at the beginning of the taxable year following the year in which the discharge occurred. Section 1017(b)(3)(B) provides that, for purposes of section 1017, the term "depreciable property" means any property of a character subject to the allowance for depreciation, but only if a basis reduction under section 1017(a) will reduce the amount of depreciation or amortization that would otherwise be allowable for the period immediately following the reduction. This would include property subject to cost recovery under section 168. Section 1.1017-1 of the regulations provides, in general, that adjustments will, except as otherwise provided in section 1.1017-2, be made to the cost or other basis of property in a specified manner and order. Section 1.1017-2 provides for a variation from the general rule that may involve adjusting the basis of only part of the taxpayer's property, or adjusting the basis of all the taxpayer's property, according to a fixed allocation. Agreement between the taxpayer and the Commissioner of Internal Revenue as to any variations from the general rule shall be effected only by a closing agreement entered into under the provisions of section 7121.

Taxpayers who own a substantial number of depreciable properties have elected under section 108 of the Code to exclude from gross income the discharge of qualified business indebtedness and have requested, as prescribed in section 1.1017-2 of the regulations, a variation that will allow the taxpayers to reduce the basis of only some of their depreciable properties (the "selected assets").

SEC. 3. APPLICATION

The Service will not issue an advance ruling or enter into a closing agreement when it appears the taxpayer will gain a significant tax advantage by adjusting the basis of only selected assets. However, the Service will generally issue an advance ruling and enter into a closing agreement permitting a variation from the general rule if the following conditions are met.

01 The taxpayer has filed or intends to file an election under section 108(d)(4) of the Code with its return for the taxable year in which the discharge of indebtedness occurred.

02 The discharge of indebtedness did not occur in a case under title 11 of the United States Code (relating to bankruptcy) nor when the taxpayer was insolvent.

03 The discharged indebtedness would not be treated as price reduction under section 108(e)(5) of the Code.

04 The taxpayer did not select the assets for basis adjustment with any preconceived plan or intention to dispose of those assets.

05 The selected assets are depreciable properties having a weighted average remaining "useful life" no longer than the weighted average remaining "useful life" of all the taxpayer's depreciable properties, including properties subject to amortization or cost recovery, but excluding fully depreciated or amortized properties owned by the taxpayer at the beginning of the taxable year following the taxable year in which the discharge of indebtedness occurred. For purposes of this representation only, the "useful life" for properties subject to cost recovery under section 168 of the Code shall be the recovery period used by the taxpayer.

06 The taxpayer has sufficient bases in the selected assets to absorb the basis adjustments required by section 1017 of the Code at the beginning of the taxable year following the taxable year in which the discharge of indebtedness occurred.

07 None of the selected assets that are depreciated under section 167 of the Code will have their bases reduced below salvage value.

08 The selected assets are not depreciated under the retirement--replacement--betterment method of accounting.

09 To ensure that ordinary income treatment eventually will be given to the full amount of basis reduction, the taxpayer agrees that when a selected asset is sold, exchanged, retired, or otherwise disposed of, an amount equal to the income excluded and attributed to that asset under the section 108 election shall be included in gross income as ordinary income and added back to the basis of the selected asset at the time of its disposition.

10 Only that portion of the basis of a selected asset remaining after applying the appropriate amount of adjustment resulting from the section 108 election shall be subject to the allowable deduction under section 167 or 168 of the Code, whichever is applicable, in the years subsequent to the year in which the discharge of indebtedness occurred.

SEC. 4. IMPLEMENTATION

A taxpayer wishing to take advantage of this procedure should file a request for a ruling under Rev. Proc. 85-44, and request that a closing agreement be entered into with the Commissioner of Internal Revenue as provided in section 1.1017-2 of the regulations. The request for ruling and closing agreement should be addressed to the Commissioner of Internal Revenue, Attention: CC:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224, and should request the application of Rev. Proc. 85-44. If such requests are approved the taxpayer must attach a copy of the ruling and closing agreement to its return for the taxable year in which the discharge of indebtedness occurred.

SEC. 5. INQUIRIES

Inquiries regarding this Revenue Procedure should be addressed to the Commissioner of Internal Revenue, Attention: CC:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

SEC. 6. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 78-16 is modified and superseded.