Rev. Proc. 78-16

Section 1. Purpose.

The purpose of this Revenue Procedure is to set 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.

Sec. 2. Background.

Section 108 of the Internal Revenue Code of 1954 provides, in part, that no amount shall be included in gross income by reason of the discharge, in whole or in part, within the taxable year of any indebtedness incurred or assumed by a corporation or by an individual in connection with properties used in a trade or business and for which the taxpayer is liable, if such taxpayer makes and files a consent to the regulations prescribed under section 1017. Section 1017 requires that the amount so excluded from gross income be applied in reduction of the basis of any property held by the taxpayer during the year in which the discharge occurred. 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 of 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 income from the discharge of indebtedness, and have requested, as prescribed by 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 properties").

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, if (a) the selected properties 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 depletion, but excluding fully depreciated, amortized, or depleted properties owned by the taxpayer at the beginning of the taxable year for which the election is made, (b) the taxpayer has sufficient basis in the selected properties to absorb the basis adjustment required by section 1017 of the Code, and (c) the properties subject to basis reduction are not depreciated under the retirement-replacement-betterment method of accounting, the Service will generally issue an advance ruling and enter into a closing agreement permitting a variation from the general rule. For administrative purposes the Service will require that the following conditions be incorporated in any closing agreement.

.01 The taxpayer agrees that a fraction of the basis adjustment required by section 1017 of the Code will be allocated to property that qualified for the investment tax credit allowed by section 38. Such fraction is no less than the ratio of the adjusted basis of the taxpayer's qualified section 38 property over the adjusted basis of all the taxpayer's depreciable property as of the first day of the taxable year for which the section 108 election is made. The taxpayer's selection of section 38 property must result in an investment tax credit recapture that is not less than the investment tax credit recapture that would result under section 1.1017-1 of the regulations. The investment credit on the section 38 property selected for basis reduction as a result of income from the discharge of indebtedness is computed to reflect the reduction in the basis of the section 38 property.

.02 The taxpayer agrees that for closing agreement purposes, when a selected property is sold, exchanged, or otherwise disposed of, an amount equal to the income deferred and attributed to that selected property under the section 108 election shall be included in the taxpayer's gross income as ordinary income. The amount of the deferred income included in gross income as ordinary income will be added to the basis of the selected property at the time it is sold, exchanged or otherwise disposed of. The amount so characterized is to effectuate the principle that, with respect to the characterization of income attributable to a discharge of indebtedness, a taxpayer making the election under section 108 to adjust basis under section 1017 should be in no better or worse position having made the election than it would have been had it actually recognized the income in the year such discharge occurred.

Sec. 4. Implementation.

A taxpayer wishing to take advantage of this procedure should file a request for a ruling under Rev. Proc. 72-3, 1972-1 C.B. 698, 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: T:C:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224, and should request the application of Rev. Proc. 78-16. 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: T:C:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.