Tax Entities and CODI
CODI in Partnerships
Exclusion at partner level – The exclusions apply at the partner level, not at the partnership level. The insolvency of the partnership does not affect the pass-through of the CODI. Each partner may use whichever exclusions they qualify for on their individual returns.
Real Property Business Debt Exclusion – The determination of whether debt is qualified as real property business indebtedness is made at the partnership level. Then, the election to apply the provision is made on a partner-by-partner basis.
IRC §108(i) Reacquisition of Business Debt Deferral – In tax years 2009 – 2010 the partnership may have elected to defer the reporting of the COD income. This election allowed either four or five years of deferral and then the inclusion of the CODI ratable in tax years 2014-2018.
If the partnership made this election, the income is passed through to the partners and the partners are NOT allowed to use any other exclusion relating to that income.
Unlike the other exclusions, this election is made at the partnership level.
CODI in S Corps
Exclusion at entity level – The exclusions are applied at the entity level, not the shareholder level. Debt discharge income that can be excluded at the entity level is not passed through to the shareholders and does not increase their basis. The reduction of tax attributes occurs after the S Corps income, loss, deductions, and credits for the tax year have passed through to it’s shareholders. A loss disallowed to shareholders, because they don‘t have enough basis to absorb it, is treated as an NOL of the S Corp.
CODI in Estates
Distributed to beneficiaries – CODI on an estate‘s final return is considered to have been distributed to the beneficiaries, who may use any exclusions or exceptions they qualify for to reduce their tax liability.
Consider disclaiming the property – If there will be no distribution of assets to the beneficiaries (because the mortgage on the home is more than the home is worth), the beneficiaries may want to disclaim their inheritance before the 9 month deadline has passed.
This will prevent the pass-through of CODI with no assets passing through
to pay the resulting taxes. The state would then become the beneficiary and the taxes would not be paid. However, if there were any accounts that passed directly to beneficiaries (401K, IRA, Annuities, etc, but not life insurance), those assets may be subject to collection by the IRS.