Real estate developer gets 45 days to make a late debt-income exclusion election

Plain-English summary

A real estate developer recognized cancellation-of-debt income after a wholly owned LLC purchased debt that had financed a condominium project. The developer's accountant reported the income on the timely filed individual return but did not advise making the election to exclude qualified real property business indebtedness income and reduce the basis of depreciable real property. After the accountant's firm identified the alternative treatment, the taxpayer promptly requested an extension. The IRS found that the taxpayer acted reasonably and in good faith by relying on a qualified professional and that relief would not prejudice the government. It granted 45 days to file an amended return and make the IRC § 108(c)(3)(C) election on Form 982. The IRS did not decide whether the income was cancellation-of-debt income or whether the taxpayer otherwise qualified for the exclusion.

Ruling snapshot

• Question: May the taxpayer make a late election to exclude qualified real property business indebtedness income and reduce depreciable-property basis?
• Outcome: Approved, with an amended return and Form 982 due within 45 days
• Key authorities: IRC §§ 108(a)(1)(D), 108(c)(2), 108(c)(3)(C); Treas. Reg. §§ 1.108-5(b), 301.9100-1, 301.9100-3

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201902024                                             Third Party Communication: None
Release Date: 1/11/2019                                       Date of Communication: Not Applicable
Index Number: 108.01-04, 9100.00-00
                                                              Person To Contact:
-------------------------------------------                   ------------------------, ID No. ------------------
--------------------------                                    ----------------------------------------------------
----------------------------                                  Telephone Number:
                                                              ----------------------
                                                              Refer Reply To:
                                                              CC:ITA:B05
                                                              PLR-113394-18
                                                              Date: October 9, 2018




Legend

Taxpayer1                     = -------------------------------------------------
Partnership                   = ---------------------------------------------------------------------------------------
                                ----------------------------------------------------
Partners 2 and 3              = ----------------------------------------------------------
Partners 4 and 5              = ---------------------------------------------------
LLC                           = ---------------------------------------------------------------------------------------
                                -----------------------------------------------------------------
x                             = ---------------------------------------------
Bank                          = ------------------------------------------
$a                            = ----------------
Date 1                        = --------------------
Date 2                        = ----------------------
Date 3                        = ------------------------
Date 4                        = ----------------------
Accountant                    = -------------------------------
Firm                          = -----------------------------------------
State                         = --------------
Year 1                        = -------
Year 2                        = -------
Year 3                        = -------
Year 4                        = -------
$b                            = ----------------
$c                            = ----------------



1
  During Year 1 through Date 4, Taxpayer filed join returns with spouse. The designation “Taxpayer” in
this document refers to one of the spouses who is seeking the extension of time to make the election on
joint return.

Dear ---------------:

This letter responds to your letter requesting an extension of time under § 301.9100-3 of
the Procedure and Administration Regulations to make a regulatory election.
Specifically, you have requested an extension of time to make an election under §
108(c)(3)(C) of the Internal Revenue Code and § 1.108-5(b) of the Income Tax
Regulations, to exclude income resulting from the discharge of qualified real property
business indebtedness and to reduce the basis of depreciable real property, effective
for Taxpayer's Year 4 tax return.

FACTS

Taxpayer uses the cash receipts and disbursements method of accounting, reports
income on a calendar year, and is a real estate developer. On or about Date 1,
Taxpayer formed Partnership to develop 3x residential condominiums. Partnership was
organized in State as a limited liability company and had five partners. Ultimately, only
2x condominiums were constructed. By Year 2, Partners 2 and 3 failed to make
required capital contributions causing their partnership interests be reduced to a point at
which they ceased being members, and pursuant to the operating agreement of
Partnership, Taxpayer’s ownership percentage increased accordingly. On Date 2,
Partners 4 and 5 gifted the remaining membership interests in Partnership to Taxpayer.

In Year 1, Partnership borrowed $a from Bank. By Year 3, only 1.2x condominiums had
been sold, and by August of Year 3, Taxpayer decided to convert the remaining
condominiums into rentals.

On Date 3, Taxpayer formed LLC, owned solely by Taxpayer. LLC purchased
Partnership’s debt from Bank for $b. As a result of the purchase, Taxpayer realized
cancellation of indebtedness (COD) income of $c.

Taxpayer engaged Accountant, a qualified tax preparer with many years of experience
at Firm, to prepare Form 1040, Individual Federal Income Tax Return for Year 4.
Accountant included $c of COD income on line 21 of Taxpayer’s Form 1040, for Year 4,
which Taxpayer timely filed.

On Date 4, after discovering Accountant’s error, Firm informed Taxpayer about an
alternative reporting position under which Taxpayer could exclude income resulting from
the discharge of indebtedness and reduce the basis of depreciable qualified real
property. At the time Taxpayer learned of the alternative, Accountant had already retired
from Firm. Shortly thereafter, Taxpayer submitted request for an extension of time to
make the requisite election.

Taxpayer represents that Taxpayer relied on Accountant to report the COD income in
the most tax-efficient manner. The most efficient approach would have been for
Taxpayer to make a § 108(c)(3)(C) election.

Taxpayer also represents that granting relief under § 301.9100-3 will not result in a
lower tax liability in the aggregate for all years to which the election applies than
Taxpayer would have had if the election had been timely made.

LAW AND ANALYSIS

Section 108(a)(1)(D) provides that gross income does not include any amount that (but
for § 108(a)) would be includible in gross income by reason of the discharge of
indebtedness if, in the case of a taxpayer other than a C corporation, the indebtedness
discharged is qualified real property business indebtedness.

Section 108(c)(2) provides, in general, that the amount excluded under § 108(a)(1)(D)
with respect to any qualified real property business indebtedness shall not exceed the
excess of the outstanding principal amount of such indebtedness (immediately before
the discharge) over the fair market value of the real property described in § 108(c)(3)(A)
(as of such time).

Section 108(c)(3)(C) requires a taxpayer to make an election to exclude COD income
under § 108(a)(1)(D).

Section 1.108-5(b) provides that the election under § 108(c)(3)(C) is made on the timely
filed (including extensions) federal income tax return for the taxable year in which the
taxpayer has discharge of indebtedness income that is excludible from gross income
under § 108(a). The election is made on a completed Form 982, Reduction of Tax
Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).

Sections 301.9100-1 through 301.9100-3 provide the standards that the Commissioner
will use to determine whether to grant an extension of time to make a regulatory
election. Section 301.9100-3(a) provides that requests for extensions of time for
regulatory elections (other than automatic extensions covered in § 301.9100-2) will be
granted when the taxpayer provides evidence (including affidavits) to establish that the
taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the
interests of the Government.

Under § 301.9100-3(b) a taxpayer is deemed to have acted reasonably and in good
faith if the taxpayer requests relief before the failure to make the regulatory election is
discovered by the Service, reasonably relied on a qualified tax professional, and the tax
professional failed to make, or advise the taxpayer to make, the election. However, a
taxpayer is not considered to have reasonably relied on a qualified tax professional if

the taxpayer knew or should have known that the professional was not competent to
render advice on the regulatory election or was not aware of all relevant facts.

In addition, § 301.9100-3(b)(3) provides that a taxpayer is deemed not to have acted
reasonably and in good faith if the taxpayer—

       (i)     seeks to alter a return position for which an accuracy-related penalty has
               been or could be imposed under § 6662 at the time the taxpayer requests
               relief, and the new position requires or permits a regulatory election for
               which relief is requested;

       (ii)    was fully informed in all material respects of the required election and
               related tax consequences but chose not to make the election; or

       (iii)   uses hindsight in requesting relief. If specific facts have changed since the
               original deadline that make the election advantageous to a taxpayer, the
               Service will not ordinarily grant relief.

Section 301.9100-3(c)(1) provides that the Commissioner will grant a reasonable
extension of time to make the regulatory election only when the interests of the
Government will not be prejudiced by the granting of relief.

Section 301.9100-3(c)(1)(i) provides that the interests of the Government are prejudiced
if granting relief would result in a taxpayer having a lower tax liability in the aggregate
for all taxable years affected by the election than the taxpayer would have had if the
election had been timely made (taking into account the time value of money).

Section 301.9100-3(c)(1)(ii) provides that the interests of the government are ordinarily
prejudiced if the taxable year in which the regulatory election should have been made or
any taxable year that would have been affected by the election, had it been timely
made, are closed by the period of limitations on assessment under § 6501(a) before the
taxpayer’s receipt of a ruling granting relief under this section.

Based on the information submitted by Taxpayer, we conclude that (1) Taxpayer has
acted reasonably and in good faith under § 301.9100-3(b), and (2) the interests of the
Government will not be prejudiced by the granting of relief under § 301.9100-3(c).

CONCLUSION

Accordingly, based solely on the facts and information submitted and the
representations made in the ruling request, we grant Taxpayer an extension of 45 days
from the date of this letter ruling to file an amended return to make the election under
§ 108(c)(3)(C) and § 1.108-5(b). The election is to be made on Form 982.

Except as expressly provided in the preceding paragraph, we do not express or imply
an opinion concerning the tax consequences of any aspect of any transaction or item
discussed or referenced in this letter. Specifically, this letter does not rule on whether
the income at issue is properly treated as COD income under § 61(a)(12). Further, we
express no opinion, nor do we possess all of the necessary information to determine
whether Taxpayer qualifies to make the election set forth in § 108(c)(3)(C), in particular:
whether Taxpayer's adjusted basis in depreciable property is greater than the amount of
COD income or what the fair market value of the real property was at the time the debt
was cancelled. Further, we express no opinion on whether and to what extent the
discharged indebtedness had been incurred or assumed by Taxpayer in connection with
real property used in a trade or business.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for ruling, it is subject to verification on examination.
In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.



                                       Sincerely,




                                       John M. Aramburu
                                       Senior Counsel, Branch 5
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)