November 5, 2008
Partnership Debt for Equity Exchanges; IRS Issues Proposed Regulations on Section 108(e)(8)

On October 30, 2008, the Internal Revenue Service released proposed regulations (REG-164370-05) to advise taxpayers on the application of Section 108(e)(8) to partnerships and their partners.

Section 108(e)(8), as amended, provides that for purposes of determining discharge of indebtedness income (COD income) of a partnership debtor, if the debtor partnership transfers a capital or profits interest in such partnership to a creditor in satisfaction of its indebtedness, be it recourse or nonrecourse, such partnership shall be treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the interest transferred.

Proposed REG-164370-05 adds detail to Section 108(e)(8) by specifying that (1) the fair market value of the interest transferred is equal to the liquidation value of such interest; (2) the excess of the indebtedness discharged over the fair market value of the partnership interest transferred in discharge, is the amount of COD income the partnership will recognize; and (3) any COD income recognized under this section shall be included in the distributive shares of the partners in the partnership immediately before such discharge.

In the proposal, the IRS also stated that the nonrecognition rule of section 721 should apply to the creditor’s contribution of partnership indebtedness, giving the contributing creditor a basis in its partnership interest equal to the adjusted basis of the indebtedness contributed.

CIRCULAR 230 DISCLOSURE
THE DISCUSSION OF TAX CONSIDERATIONS WAS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED BY ANY TAXPAYER, FOR THE PURPOSE OF AVOIDING TAX PENALTIES THAT MAY BE IMPOSED BY THE INTERNAL REVENUE SERVICE.  ANY TAX ADVICE CONTAINED HEREIN WAS WRITTEN TO SUPPORT THE PROMOTION OR MARKETING OF THE TRANSACTIONS OR MATTERS ADDRESSED BY THE WRITTEN ADVICE. EACH PARTY SHOULD SEEK ADVICE BASED ON THE PARTY’S PARTICULAR CIRCUMSTANCES FROM AN INDEPENDENT TAX ADVISOR.