IRS denies a six-year-late election to exclude discharged real-property business debt as based on hindsight

Plain-English summary

Section 108(c)(3)(C) lets a non-corporate taxpayer elect to exclude from income the cancellation of "qualified real property business indebtedness," in exchange for reducing the basis of depreciable real property. The election must be made on a timely filed return. Here, taxpayers who owned real estate through LLCs had loan debt discharged when a property was sold, but at the time the return was prepared their advisor saw no benefit to the election because a large § 1231 loss already offset the cancellation-of-debt income, so no election was made. Years later, after a state tax authority disallowed the § 1231 loss, the taxpayers asked the IRS for a late election, more than six years after the deadline. The IRS denied relief. It found the taxpayers used hindsight (the state proceeding is a change of facts that made the election newly attractive), the government's interests would be prejudiced because the relevant years were closed by the statute of limitations, the six-year delay was not reasonable, and granting relief would not serve sound tax administration. Each ground independently supported the denial.

Ruling snapshot

• Question: May taxpayers get a § 301.9100-3 extension to make a late § 108(c)(3)(C) election more than six years after the deadline, prompted by a later state tax disallowance?
• Outcome: Denied (hindsight; government prejudiced by closed statute of limitations; delay unreasonable).
• Key authorities: IRC § 108(a)(1)(D), (c)(3), (d)(9); Treas. Reg. §§ 1.108-5, 301.9100-3(b)(3), (c)(1); Rev. Proc. 2021-1 § 5.03(2).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202205023 Third Party Communication: None
Release Date: 2/4/2022 Date of Communication: Not Applicable
Index Number: 108.01-00, 108.01-04,
108.02-01 Person To Contact:
--------------------------
---------------------------------- ID No. -----------------
-------------------------- Telephone Number:
------------------------------------ --------------------
Refer Reply To:
CC:ITA:B04
PLR-128073-19
Date:
November 04, 2021

Taxpayers = ----------------------------------

Entity 1 = -------------------------------

Entity 2 = -----------------------------

Entity 3 = ------------------------------------

Business Activities = -------------------------------------

Property = ---------------------------------------------------------

Loan = --------------------------------------

Bank = ---------------------------

Advisor = --------------

Document = -----------------

State = -------------

State Tax Entity = -----------------------------------------

Date 1 = ---------------------------

Date 2 = ---------------------
PLR-128073-19 2

Date 3 = -----------------------

Date 4 = ------------------------

Date 5 = -------------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

Percentage 1 = ------

Percentage 2 = ------

Amount 1 = ---------------------

Amount 2 = ---------------

Amount 3 = ---------------

Amount 4 = -------------------

Amount 5 = ---------------

Amount 6 = ---------------

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

This letter responds to your request for a private letter ruling granting an extension of
time under section 301.9100-3 of the Procedure and Administration Regulations to
make an election under section 108(c)(3)(C) of the Internal Revenue Code to exclude
from income the discharge of qualified real property business indebtedness for tax year
Year 1. Your authorized representatives have provided additional information and
participated in an adverse conference, as provided in Revenue Procedure 2021-1. As
set forth below, we have denied your request.

                                     FACTS

PLR-128073-19 3

Based on the representations of Taxpayers and the information provided by your
authorized representative, the facts are as follows.

Taxpayers together indirectly own a Percentage 1 interest Entity 1, a limited liability
company formed in State, through their Percentage 2 ownership interest in Entity 2, a
limited liability company for federal tax purposes. Taxpayers also own a Percentage 2
interest in Entity 3, a limited liability company for federal tax purposes. Entity 1, formed
in Year 2, is in the business of Business Activities and was the sole owner of real
property located at Property.

Pursuant to a Loan dated Date 1, the Property was encumbered by a loan payable to
Bank. On Date 2, the total outstanding loan balance was Amount 1.

On Date 2, Entity 1 sold the Property to Entity 3 for Amount 2. Entity 1 paid Amount 3 to
Bank on the outstanding loan balance, and Bank discharged the remaining loan
balance, amounting to Amount 4. For tax year Year 1, Entity 1 reported a loss of
Amount 5 under section 1231 of the Internal Revenue Code and cancellation of debt
(COD) income of Amount 6.

Taxpayers engaged Advisor, a qualified tax professional, to prepare their tax returns for
tax year Year 1. Taxpayers and Advisor state that (1) Advisor did not advise Taxpayers
on the availability of the section 108(c)(3)(C) election, (2) the failure to make the
election was due to inadvertence and not tax planning, and (3) that Taxpayers would
have made the election if its availability had been known. For tax year Year 1, Entity 1
reported no taxable income as its 1231 loss exceeded income. Advisor provided
contemporaneous Year 1 return documents, including a Document, showing
computations related to the 1231 loss and COD income resulting in Entity 1’s 1231 loss
being only partially offset by the COD income. Advisor, during discussions with us,
stated that at the time he prepared Entity 1’s and Taxpayers’ returns there was no
benefit to making the § 108(c)(3)(C) election because of the large 1231 loss. As such,
the COD income was reported and recognized in Year 1 and Advisor did not advise to
elect to exclude the COD income and reduce tax attributes.

The State Tax Entity examined Entity 1’s state tax return for tax year Year 1 and
disallowed the section 1231 loss pursuant to I.R.C. section 707(b)(1)(B)1. The State Tax
Entity determined that the sale of the Property by Entity 1 to Entity 3 constituted a sale
or exchange of property, directly or indirectly, between two partnerships in which the
same persons own, directly or indirectly, more than 50% of the capital interest or profits
interests. The state tax matter is currently under appeal pending the resolution of this
private letter ruling request. The Service did not examine Taxpayers’ Year 1 Federal
income tax return, and the claimed 1231 loss, prior to the expiration of the statute of
limitations and has no ability to now do so.

1 State’s tax law conforms to federal tax law with modification.
PLR-128073-19 4

On Date 3, more than six years after a timely election was required to be made,
Taxpayers submitted this request for an extension of time under §§ 301.9100-1 and
301.9100-3 to make an election under section 108(c)(3)(C) for tax year Year 1. The
representations and facts provided establish that allowing the late election would require
amended returns for closed tax years Year 1-Year 3 (and possibly beyond) that would
affect each years’ computations and amount of tax due; however, Taxpayers concede
that the statute of limitation is closed for those years so that Taxpayers may not request
a refund and the Service may not examine the returns and/or assess additional tax.

On Date 4, we informed your representative that we were tentatively adverse. We
subsequently held an adverse conference of right and follow-up telephonic conferences.
In addition, your representative provided additional information and documents. On
Date 5, we informed your authorized representative that we had made a final adverse
determination.

                                      LAW

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

Section 108(c)(1) provides that the amount excluded from income under § 108(a)(1)(D)
shall be applied to reduce basis of the depreciable real property of the taxpayer.

Section 108(c)(3) provides that the term “qualified real property business indebtedness”
means indebtedness that:

  (A) was incurred or assumed by the taxpayer in connection with real property
      used in a trade or business and is secured by such real property;
  (B) was incurred or assumed before January 1, 1993; and
  (C) with respect to which such taxpayer makes an election to have § 108(c)(3)
      apply.

Section 108(d)(6) provides that in the case of a partnership, § 108(a) and (c) apply at
the partner level.

Section 108(d)(9)(A) provides that an election under § 108(c)(3)(C) shall be made on
the taxpayer's return for the taxable year in which the discharge occurs or at such other
times as may be permitted in regulations prescribed by the Secretary.

Section 108(d)(9)(C) provides that an election referred to in § 108(d)(9)(A) shall be
made in such manner as the Secretary may by regulations prescribe.
PLR-128073-19 5

Section 1.108-5 of the Income Tax Regulations, which is effective December 27, 1993,
provides that the election to treat indebtedness as qualified real property business
indebtedness under § 108(c)(3) is to be made on Form 982 and attached to a timely-
filed return for the taxable year in which the taxpayer has discharge of indebtedness
income that is excludible under section 108(a).

Section 301.9100-1(c) provides that the Commissioner has the discretion to grant a
reasonable extension of time to make a regulatory election. Section 301.9100-1(b)
defines the term “regulatory election” as including any election the due date for which is
prescribed by a regulation. Because the due date of the section 108(c)(3)(C) election is
prescribed in § 1.108-5, that election is a regulatory election.

Sections 301.9100-1 through 301.9100-3 provide the standards the Commissioner will
use to determine whether to grant an extension of time to make the election. Section
301.9100-2 provides automatic extensions of time for making certain elections. Section
301.9100-3 provides extensions of time for making regulatory elections that do not meet
the requirements of § 301.9100-2.

Section 301.9100-3(a) provides that requests for relief subject to § 301.9100-3 will be
granted when the taxpayer provides evidence, including affidavits described in
§ 301.9100-3(e), to establish to the satisfaction of the Commissioner that the taxpayer
acted reasonably and in good faith, and the grant of the relief will not prejudice the
interests of the Government.

Section 301.9100-3(b)(3)(iii) provides that a taxpayer is considered to have not acted
reasonably and in good faith if the taxpayer uses hindsight in requesting relief. If specific
facts have changed since the original deadline that make the election advantageous to
the taxpayer, the Service will not ordinarily grant relief.

Section 301.9100-3(c)(1) provides that the Service will grant a reasonable extension of
time to make a regulatory election only when the interests of the Government will not be
prejudiced by the granting of the 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. Under
§ 301.9100-3(c)(1)(ii), 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 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 § 301.9100-3. However, the IRS may condition a grant of relief on
the taxpayer providing the IRS with a statement from an independent auditor (other than
an auditor providing an affidavit pursuant to paragraph (e)(3) of this section) certifying
that the interests of the Government are not prejudiced by means of subsection (c)(1)(i).
PLR-128073-19 6

Section 5.03(2) of Revenue Procedure 2021-1 (and its predecessors) provides that the
Service ordinarily will not issue a § 301.9100 ruling if the period of limitation on
assessment under § 6501(a) for the taxable year in which an election should have been
made, or for any taxable years that would have been affected by the election had it
been timely made, will expire before receipt of a § 301.9100 letter ruling. However, the
Service may issue the letter ruling if the taxpayer consents to extend the period of
limitation on assessment under § 6501(c)(4) for the taxable year in which the election
should have been made and for any taxable years that would have been affected by the
election had it been timely made.

                                 DISCUSSION

Based on the facts provided and representations made, we deny Taxpayers’ request for
relief under § 301.9100-3. We find that Taxpayers did not act reasonably and in good
faith because the request is based on hindsight and we find the interests of the
Government would be prejudiced by granting the requested relief because the statute of
limitations is closed for Year 1 and subsequent years affected by the late election.

In addition, we find that the requested six-year extension is not a reasonable extension
of time because the Taxpayers’ should have discovered the missed election before the
statute of limitations expired and/or the state tax authority disallowed the 1231 loss.
Lastly, we find that granting relief would not be in the interest of sound tax
administration because the expired statute of limitations prevents the Service from
examining Entity 1’s and Taxpayers’ Year 1 return, as well as subsequent affected
returns. Each of the reasons described herein independently support our denial.

Under § 301.9100-3(b)(3), a taxpayer is considered to have not acted reasonably and in
good faith if the taxpayer uses hindsight in requesting relief. The representations and
statements provided establish that at the time the Year 1 return was prepared, Advisor
was aware of the § 108 election, the election provided no benefit to Taxpayers, and
Taxpayers have no explanation as to why they would have made the election if
informed of its availability. We find Taxpayers’ statement that they would have made the
election to be self-serving and unsupported by the facts. The sole reason provided for
seeking relief to make the election is to affect the outcome of a subsequent state tax
proceeding. The state tax proceeding is a change of facts after the original deadline that
makes the election advantageous to the Taxpayers and, as such, establishes that
Taxpayers request is due to hindsight.

Under § 301.9100-3(c)(1)(ii), 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 affected by the election had it been timely made, are closed by the period of
limitations on assessment under § 6501(a). Tax year Year 1, for which Taxpayers are
seeking to make the late section 108(c)(3)(C), is closed. Subsequent tax years, years in
which Taxpayers did not reduce basis of depreciable real property as required by
section 108(c)(1) but rather took depreciation deductions, are closed as well.
PLR-128073-19 7

The Service may condition a grant of relief on the taxpayer providing a statement from
an independent auditor certifying that the taxpayer will not have a lower tax liability
should the late election be allowed. Taxpayers offered to provide a certification after we
notified them that we were tentatively adverse; however, an independent audit and
certification is insufficient as it assumes the propriety of the § 1231 loss, the eligibility for
the § 108 election, and that other positions and computations on the returns are proper,
which the Service is not permitted to examine. For this reason, and other legal and
administrative considerations, § 5.03(2) of Revenue Procedure 2021-1 provides that the
Service ordinarily will not issue a § 301.9100 ruling if the period of limitation on
assessment under § 6501(a) has expired for the taxable year in which an election
should have been made, or for any taxable years that would have been affected by the
election had it been timely made.

                                    CONCLUSION

Based on the facts and representations provided, and for the reasons discussed,
Taxpayers are not granted an extension of time under § 301.9100-3 to make a late
§ 108(c)(3)(C) election because Taxpayers did not act reasonably and in good faith, the
interests of the Government would be prejudiced, the amount of time requested is not
reasonable, and granting the extension would not be in the best interests of tax
administration.

This letter is being issued electronically in accordance with Rev. Proc. 2020-29, 2020-
21 I.R.B. 859. A paper copy will not be mailed to the taxpayer. Pursuant to the Form
2848, Power of Attorney and Declaration of Representation, on file, we are sending a
copy of this letter to your authorized representatives.

                                                Sincerely,




                                                Ronald J. Goldstein
                                                Senior Technician Reviewer, Branch 4
                                                (Income Tax & Accounting)

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