IRS Determines That Debt Secured By Wholely Owned Dissregarded Entity Qualifies For Income Exclusion on Workout

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The Internal Revenue Service has issue Revenue Procedure 2014-20 which provides a safe harbor under which the IRS will, under certain defined circumstances, treat indebtedness that is secured by 100 percent of the ownership interest in a disregarded entity that holds real property as indebtedness that is secured by real property for purposes of § 108(c)(3)(A) of the Internal Revenue Code.

This revenue procedure will assist taxpayers with so-called “mezzanine” financing in workouts and similar circumstances.

Often borrowers incur debt in connection with real property used in a trade or business. If the debt is later discharged, the income from the discharge of indebtedness may be excluded from gross income if certain requirements are met. In some cases, the real property is held by the borrower in an entity that is wholly owned by the borrower, and is, for federal tax purposes, disregarded as owner. In these cases, the debt may be secured by the borrower’s ownership interest in the disregarded entity holding the real property.

Indebtedness that satisfies the requirements of this revenue procedure will be treated as indebtedness secured by real property for purposes of § 108(c)(3)(A). Provided the indebtedness meets the other requirements of § 108(c)(3), such indebtedness will be QRPBI and, accordingly, any income from the discharge of such indebtedness will be excluded from the taxpayer’s gross income pursuant to§108(a)(1)(D) subject to the limitations provided in § 108(c). Further, as provided in §108(c)(1), the basis of depreciable real property of the taxpayer will be reduced by the amount excluded from gross income.

Revenue Procedure 2014-20, will be in Internal Revenue Bulletin 2014-09 on Feb. 24, 2014.

In accordance with Circular 230 Disclosure

Mr. Marini concentrates his practice in Representation before the IRS and All Other Tax Authorities, IRS Collections, Offers in Compromise, Installment Payment Plans, Appeals, Sales Tax Audits, International and Tax Law, Asset Protection and Estate Planning.

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