The Hidden Tax Trap Associated with Cancellation of Debt

The Hidden Tax Trap Associated with Cancellation of Debt Justin Pierce Berutich and Richard A. Morgan * In this article, the authors discuss the e ects of cancellation of debt income resulting from loan workouts upon guarantors of single purpose limited liability companies holding title to collateral real property. The e ects of relaxed institutional standards and ease of access to credit markets gave rise to the largest bubble in U.S. real estate prices since the Great Depression. By 2005, euphoria and speculation in real property investment slowed dramatically. Between 2005 and 2008, prompted substantially by the collapse of Lehman Brothers and Bear Stearns, a decade of growth and vast investment in real estate was virtually eliminated in just over three years. The legacy of this crisis is unmistakable real estate investment companies and developers su ering liquidity de cits and owning signi cantly devalued property. The past several years have been marked by investment companies and developers, among others, working with lenders to modify obligations or convey deeds to properties in exchange for a cancellation of debt ( COD ) obligations. After engaging in exhausting efforts for months, if not years, to resolve these real estate-related debts, investment companies and developers often take delivery of crippling news advising of a massive tax liability. Unwittingly, obligors, guarantors, investors, and developers alike have fallen prey to the hidden tax trap associated with the cancellation of their debt. This article discusses the e ects of cancellation of debt income resulting from loan workouts upon guarantors of single purpose limited liability companies 1 holding title to collateral real property. Introduction The Internal Revenue Code ( IRC ) de nes gross income as all income from whatever source derived. 2 While an exceptionally encompassing de nition, the creation of a loan does not generate income for the debtor. The funding and transmission of loan proceeds to a debtor (which might otherwise be * Justin Pierce Berutich is an associate with Buchanan Ingersoll & Rooney PC who received his LL.M. in Taxation from New York University School of Law. Mr. Berutich focuses his practice on litigation matters pertaining to business and corporate law. He has particular experience in state and federal taxation, nancing, mergers and acquisitions, business development, commercial agreements, human resources, corporate governance, regulatory compliance and real estate. Richard A. Morgan is a co-managing shareholder of the rm's o ces in Miami and Aventura, Florida, and is a member of the rm's Board of Directors. He also heads the rm's Florida litigation practice. Morgan focuses his practice on a broad spectrum of complex litigation involving banking, UCC issues, regulatory matters, lender liability, fraud, defalcation and construction-defect matters. He has litigated a variety of commercial contractual disputes including non-compete agreements, employment agreements and real property disputes. The authors can be reached at justin.berutich@bipc.com and richard.morgan@bipc.com, respectively. 5

The Real Estate Finance Journal viewed as an economic bene t and, thus, income) is o set by the debtor's promise to repay the debt. Further, repayment of a loan does not generate income because the reduction in liability of the note coincides with the o set by repayment. 3 That said, the IRC does speci cally include as income amounts associated with the discharge of indebtedness, commonly referred to as COD income. 4 This income inclusion is the insidious, hidden trap from where many debtors plunge after negotiating with lenders to eliminate some or all of their debt. Cancellation of Debt Income While there are seemingly endless scenarios resulting in COD income being attributed, 5 the rationale inherent in COD income principles is the same the cancellation of indebtedness provides the debtor with an economic bene t that is equivalent to income. 6 If cancellation of debt income is incurred by a taxpayer, he/she will receive a Form 1099-C from the creditor delineating the amount of the canceled debt. That amount must be acknowledged and included as gross income unless the taxpayer meets an exclusion or exception. The following discusses how cancellation of debt income resulting from loan workouts a ects guarantors of single purpose limited liability companies holding title to collateral real property. E ect on a Guarantor of the Debt Obligation The Internal Revenue Service ( Service ), generally, agrees that a guarantor (whether or not the primary obligor has defaulted and the guarantor has become liable for the indebtedness) does not realize COD income on release of a liability. 7 The United States Tax Court in Whitmer v. Commissioner held that a guarantor did not realize cancellation of debt income when the lender released the primary obligor from the debt obligation. In Whitmer, a taxpayer formed a wholly owned corporation where he served as president. In that capacity, the taxpayer entered into a contract with ITT Life Insurance Corp. ( ITT ) and personally guaranteed the corporation's performance under the ITT contract. 8 The corporation eventually terminated its business with ITT and ITT sued both the corporation and taxpayer for repayment of advances. Litigation eventually settled resulting in all parties being released from claims in exchange for the taxpayer paying ITT a modest sum. Following performance under the settlement, the Service determined that ITT forgave $212,000 in return for the modest payment and classi ed the $212,000 as COD income for the taxpayer. 9 The Whitmer court noted that [i]t is hornbook law that gross income includes income from the discharge of debt, and that a taxpayer may realize COD income by paying an obligation at less than its face value. 10 That said, the court acknowledged that established COD income law does not compel imputation of COD income to a guarantor from a discharge of debt. 11 Instead, the court focused on the fact that the loan proceeds were dispersed to the corporation not the individual taxpayer. 12 Thus, forgiveness of the debt did not increase the taxpayer's net worth; it simply prevented the taxpayer's net worth from being decreased. 13 Because the taxpayer's net worth did not increase as a result of the settlement, the court reasoned he did not receive COD income. 14 Unlike the typical COD scenario where a taxpayer receives nontaxable loan proceeds and a discharge of indebtedness leads to an increase in the debtor's assets, in the case 6

The Hidden Tax Trap Associated with Cancellation of Debt of a guarantor, income is not realized upon the discharge of the debt. The discharge of debt does not increase the guarantor's net worth, but simply prevents the decline of net worth. Since there is no COD income, an analysis of whether COD income could be excluded is moot. 15 It should be noted, however, that in certain fact speci c business transactions where the release of the guarantee occurs after the guarantor becomes primarily liable or where the guarantee obligation is satis ed by a third party, the IRS may take the position that guarantor has incurred cancellation of debt income or some other taxable event (i.e., a disguised corporate dividend). 16 E ect on a Member of the LLC A guarantor of a single purpose LLC that holds title to collateral real estate is, more often than not, also a member of the LLC. Under that fact pattern, a more complex and detailed analysis is mandated to determine how LLC members are a ected by COD income. LLCs are often taxed as partnerships (a ow-through entity). 17 When an LLC is the recipient of COD income, the intricacies of partnership taxation principles are invoked to allocate COD income among the members/ partners. 18 When an LLC receives COD income, the IRC provides for an increase in a member's adjusted basis in the LLC in an amount equal to the COD income allocated to that individual member. 19 Each member's tax basis is then decreased by a commensurate amount equal to that member's share of the debt reduction. 20 The decrease in the member's tax basis is deemed to be a cash distribution to the member. 21 As a result of the matching increase and decrease, the member's adjusted basis would remain unchanged and the member would not recognize any additional amounts of income or gain under the IRC (i.e. no COD Income is allocated to the partner or included in the partner's income). 22 Where COD income allocated to a member is less than the amount of the debt that the member is deemed to be relieved of, the result is the recognition of a gain 23 under the IRC. 24 This mismatch results in the recognition of COD income. The LLC and member may seek relief under IRC Section 108, a provision that allows for the exclusion of COD income in certain speci ed circumstances. 25 These circumstances include: (i) (ii) (iii) (iv) bankruptcy discharges; taxpayer insolvency; quali ed real property indebtedness; and qualifying new Section 108(i) associated with the American Recovery and Reinvestment Tax Act of 2009. 26 Bankruptcy Discharge Gross income does not include any COD income if the discharge of the indebtedness occurs in bankruptcy. 27 This exclusion is often of modest value to a member given that the exclusion is applied at the partnership level. 28 If the entity's debt is discharged in bankruptcy where the entity (but not its members) is the bankrupt debtor, the resulting COD income passes through to the partners who cannot take advantage of the entity's bankruptcy exception. 29 The exclusion, however, would apply if the individual member was a debtor in the bankruptcy or if 7

The Real Estate Finance Journal the member was granted a debt discharge under an individual bankruptcy ling. 30 It is interesting to note that the Tax Court held, in Gracia v. Commissioner, that a solvent general partner of a partnership could exclude his allocable share of COD income under the bankruptcy exclusion based on the bankruptcy of the partnership. 31 In the Gracia matter, the general partner's liability, for the partnership's debt was discharged pursuant to an order of the bankruptcy court, which speci cally provided that the general partner was subject to the jurisdiction of the bankruptcy court. Based on the bankruptcy court order, the Tax Court held that the general partner could rely on the bankruptcy exclusion to avoid COD income from the discharge of the taxpayer's debt as a result of the partnership's bankruptcy case. 32 Based on the Gracia ruling, solvent partners in bankrupt partnerships may be able to take advantage of the bankruptcy exclusion (without personally ling for bankruptcy) by obtaining an order from the bankruptcy court stating that the partners are subject to the court's jurisdiction. 33 Insolvency Gross income does not include any COD income if the discharge of the indebtedness occurs while the taxpayer is insolvent. 34 Similar to the bankruptcy exception, the insolvency exception applies at the partnership level. 35 For an individual member to bene t from the insolvency exclusion, he/she must be personally insolvent when the discharge occurs. The member is insolvent if, and to the extent that, liabilities exceed the fair market value of assets determined immediately prior to discharge. 36 Determining whether insolvency exists is more complex than it rst appears because even assets exempt from creditors' claims under state law are included in determining a taxpayer's insolvency. 37 Thus, if a debtor's assets, including assets exempt from the claims of creditors under State law, exceed liabilities, then the debtor, according to the IRS, has the ability to pay a tax on income from the discharge of indebtedness and may not take advantage of the insolvency exclusion. 38 Additionally, the insolvency exclusion applies only to the extent that the member is insolvent. 39 Quali ed Real Property Business Indebtness A taxpayer may exclude COD income from gross income if the indebtedness discharged is quali ed real property business indebtedness. 40 Quali ed real property business indebtedness means indebtedness which: (1) was incurred or assumed by the entity in connection with real property used in a trade or business; (2) is secured by the real property; (3) was incurred or assumed before January 1, 1993, or is quali ed acquisition indebtedness; and (4) the member of the entity makes an election to have the exclusion apply. 41 Quali ed acquisition indebtedness means indebtedness incurred or assumed for the purpose of acquiring, constructing, reconstructing, or substantially improving the real property. 42 The amount of excluded COD income from quali ed real property business debt cannot exceed the aggregate adjusted bases of depreciable real property held by the member immediately before the debt discharge. This 8

The Hidden Tax Trap Associated with Cancellation of Debt does not include any depreciable property that the taxpayer acquired in contemplation of a discharge of quali ed real property business indebtedness. 43 Additionally, where the indebtedness exceeds the fair market value of the qualifying real property, the amount excluded is limited to the excess outstanding principal amount of the indebtedness immediately before the discharge, less the net fair market value of the qualifying real property. For purposes of Section 108, net fair market value means the fair market value of the qualifying real property, reduced by the outstanding principal amount of any other quali ed real property business indebtedness that is secured by such property immediately before and after the discharge. 44 The quali ed real property business indebtedness exclusion can be seen in this simpli- ed example. 45 Taxpayer ( TP ) who is neither bankrupt nor insolvent owns a building used in her trade/business with a fair market value and basis of $150,000, which is subject to a rst mortgage of $110,000 (securing TP's debt) and a second mortgage of $90,000 (also securing TP's debt). 46 TP enters into a workout agreement with the second mortgagee thereby reducing the second mortgage debt to $30,000 (resulting in $60,000 of COD income). TP's exclusion of COD income would be limited to $50,000 because the principal amount of the discharged debt immediately before the discharge ($90,000) less the fair market value of the property, reduced by the outstanding principal amount of the other quali ed indebtedness, equals $50,000 [i.e., the outstanding principal amount immediately before discharge ($90,000) less the Fair Market Value of the property ($150,000) reduced by other quali ed real property business indebtedness ($110,000); hence, $90,000 $40,000 = $50,000]. The remaining $10,000 of debt-discharge income must be included in gross income. If the election is made, the entity must treat the tax basis reduction as accelerated depreciation, that could cause the exclusion to be of little bene t to an individual member should the property be foreclosed or sold as part of the discharged debt immediately after the discharge because the member will be allocated the gain on the sale (resulting from a recapture of the depreciation). 47 When applying this exclusion to property owned by an entity taxed as a partnership, the determination of whether the debt is quali ed real property business indebtedness and the applicability of the fair market value limitation is made at the partnership level (i.e. a review of the trade/business conduct and real property owned by partnership). 48 However, the election to apply the quali ed real property business indebtedness exclusion is made at the partner level on a partnerby-partner basis. 49 Further, should an individual partner elect the exclusion, the individual partner's basis in the partnership's property is reduced by the amount of the Partner's COD income excluded. 50 American Recovery & Reinvestment Tax Act of 2009 Section 108(i) was added to the Code by the American Recovery and Reinvestment Tax Act of 2009. 51 In general, Section 108(i) provides for an election, by the entity, if the COD income (realized from a cancellation, reacquisition, or modi cation of a business debt) was incurred after December 31, 2008, and before January 1, 2011. 52 If the election 9

The Real Estate Finance Journal was made, the COD income is then included in the member's gross income proportionately over the ve-taxable-year period beginning in 2014. 53 If an entity elected to defer the COD income under Section 108(i), it may not also take advantage of other Section 108 exclusions. 54 Any income deferred under this Section 108(i) is allocated to the partners in the partnership in the same way the amounts would have been included, immediately before the discharge, in such member's distributive share as if the income were recognized at that time. 55 Any decrease in a member's share of entity liabilities as a result of the discharge is not taken into account at the time of the discharge 56 to the extent it would cause the member to recognize gain. 57 Conclusion Investment companies and developers that are working with their lenders to modify debt instruments or convey properties in exchange for a cancelation of their debt obligations must assess the impact of COD income. This analysis ought to be ongoing but, certainly examined thoroughly at the inception of settlement negotiations to avoid falling into the hidden tax trap associated with debt cancellation. Guarantors of the indebtedness generally should not be concerned with COD income because the discharge of the debt does not increase the guarantor's net worth, but merely prevents his/her net worth from being decreased. However, if the guarantor is also a member of an LLC taxed as a partnership, further examination is essential to avoid a large tax liability. Pre-workout planning a ords entities and members the opportunity to avoid unexpected hazards that accompany COD income and associated taxes. 58 NOTES: 1 An LLC is an entity created by state statute. The IRS uses tax entity classi cation, which allows the LLC to be taxed as a corporation, partnership, or sole proprietor, depending on elections made by the LLC and the number of members. A single member LLC can be either a corporation or a single member disregarded entity. A multi-member LLC can be either a partnership or a corporation, including an S corporation. For the purposes of this article, references to an LLC refer to an entity with multiple members being taxed as a partnership, unless otherwise noted. 2 I.R.C. 61(a). 3 U.S. v. Kirby Lumber Co., 1931-2 C.B. 356, 284 U.S. 1, 3, 52 S. Ct. 4, 76 L. Ed. 131, 2 U.S. Tax Cas. (CCH) P 814, 10 A.F.T.R. (P-H) P 458 (1931); C.I.R. v. Jacobson, 1949-1 C.B. 40, 336 U.S. 28, 38, 69 S. Ct. 358, 93 L. Ed. 477, 49-1 U.S. Tax Cas. (CCH) P 9133, 37 A.F.T.R. (P-H) P 516, 7 A.L.R.2d 857 (1949); see also, C.I.R. v. Tufts, 1983-1 C.B. 120, 461 U.S. 300, 307, 310 311 n.11, 103 S. Ct. 1826, 75 L. Ed. 2d 863, 83-1 U.S. Tax Cas. (CCH) P 9328, 51 A.F.T.R.2d 83-1132 (1983); U.S. v. Centennial Sav. Bank FSB, 499 U.S. 573, 582 (U.S. 1991). 4 IRS 61(a)(12). 5 Several of the main ways property owners incur COD income are as follows: (a) settle the debt for less than the amount owed; (b) signi cant modi cations of the debt instrument; (c) use of equity in the debtor to satisfy the debt; (d) sale of property through bankruptcy; (e) foreclosure of the property; (f) presenting a deed-in-lieu of foreclosure. See, e.g., Reg. 1.1001-3(b), (e)(1), (2) to (6); I.R.C. 108; Proposed Treas. Reg. 1.108-8; I.R.C. 705. 6 See, U.S. v. Kirby Lumber Co., 1931-2 C.B. 356, 284 U.S. 1, 52 S. Ct. 4, 76 L. Ed. 131, 2 U.S. Tax Cas. (CCH) P 814, 10 A.F.T.R. (P-H) P 458 (1931); Friedman v. C.I.R., 216 F.3d 537, 44 Collier Bankr. Cas. 2d (MB) 355, 2000-1 U.S. Tax Cas. (CCH) P 50515, 85 A.F.T. R.2d 2000-2210, 2000 FED App. 0195P (6th Cir. 2000), a 'g Friedman v. C.I.R., T.C. Memo. 1998-196, T.C.M. (RIA) P 98196, 75 T.C.M. (CCH) 2383 (1998), judgment a 'd, 216 F.3d 537, 44 Collier Bankr. Cas. 2d (MB) 355, 2000-1 U.S. Tax Cas. (CCH) P 50515, 85 A.F.T.R.2d 2000-2210, 2000 FED App. 0195P (6th Cir. 2000); Stewart v. C.I.R., T.C. Summ. Op. 2012-46, 2012 WL 1842974 (T.C. 2012); I.R.C. 108. 7 Whitmer v. C.I.R., T.C. Memo. 1996-83, T.C.M. (RIA) P 96083, 71 T.C.M. (CCH) 2213 (1996) (shareholder/guarantor not taxable on cancellation of debt owed by wholly owned debtor corporation, Landreth v. Commissioner of Internal Revenue, 50 T.C. 803, 813, 1968 WL 1462 (T.C. 1968), acquiescence recommended, 1968 WL 16661 (I.R.S. AOD 1968) and acq., 1969-2 C.B. xxiii, follows); Payne v. Commissioner, 75 T.C.M. (CCH) 2548 (1998). See, also, Treas. Reg. 1.6050P-1(d)(7) (for purposes of reporting, guarantor is not a debtor). See, also, Instructions for Form 1099-A and 1099-C (2012) Exceptions, para. 7, [Lenders] are not required to le Form 1099-C for a guarantor or surety. A guarantor is not a debtor for 10

The Hidden Tax Trap Associated with Cancellation of Debt purposes of ling Form 1099-C even if demand for payment is made to the guarantor. 8 Whitmer, T.C. Memo. 1996-83 at 2. 9 Whitmer,T.C. Memo. 1996-83 at 2 3. 10 Whitmer,T.C. Memo. 1996-83 at 4 (internal citations omitted). 11 Whitmer,T.C. Memo. 1996-83 at 2 3 (distinguishing the matter before the court with the matter addressed in U.S. v. Kirby Lumber Co., 1931-2 C.B. 356, 284 U.S. 1, 52 S. Ct. 4, 76 L. Ed. 131, 2 U.S. Tax Cas. (CCH) P 814, 10 A.F.T.R. (P-H) P 458 (1931)) (the seminal case on COD income). 12 Whitmer,T.C. Memo. 1996-83. 13 Whitmer, supra, T.C. Memo 1996-83 at 4. 14 Whitmer,T.C. Memo. 1996-83. 15 I.R.C. 108 allows for the exclusion for discharge of indebtedness income in certain speci ed circumstances. However, the exclusions are generally conditioned upon the taxpayer giving up certain tax bene ts. 16 See, e.g., Tennessee Securities, Inc. v. C.I.R., T.C. Memo. 1978-434, T.C.M. (P-H) P 78434, 37 T.C.M. (CCH) 1803, 1978 WL 3100 (1978), decision a 'd, 674 F.2d 570, 82-1 U.S. Tax Cas. (CCH) P 9297, 49 A.F.T.R.2d 82-1102 (6th Cir. 1982) (holding that, when a taxpayer guaranteed debt and then had his own controlled corporation satisfy the guaranty, the guarantor-shareholder received a constructive dividend from his controlled corporation and, thus, realized income); Marcaccio v. C.I.R., T.C. Memo. 1995-174, T.C.M. (RIA) P 95174, 69 T.C.M. (CCH) 2420 (1995) (a partner who guaranteed a portion of partnership nonrecourse debt was sued by the creditor after the partnership defaulted. After the partnership terminated, the creditor settled the debt for less than the guaranteed amount and the tax court determined that the taxpayer realized COD Income equal to the di erence between the guaranteed amount and the amount the taxpayer paid to the creditor. The IRS focused on the fact that the taxpayer was the primary obligor of the debt at the time of forgiveness). 17 Entities that are taxed as partnerships do not pay tax on their income. The partnership acts as a conduit, through which its various items of income and loss ow to the individual partners. 18 The taxation of partnerships and partners is governed by Subchapter K (I.R.C. 701 to 761) and its related regulations. The remainder of the article treats the limited liability company as one being taxed as a partnership, unless otherwise noted. 19 I.R.C. 705(a)(1)(A) and (B). 20 I.R.C. 752(b) and 733(l). 21 I.R.C. 752. 22 See, Rev. Rul. 92-97, 1992-2 C.B. 124; Rev. Rul. 94-4, 1994-1 C.B. 195; I.R.C. 731 generally provides for nonrecognition of gain or loss to all parties when partnership property or money is distributed. 23 COD Income and a deemed taxable distribution. 24 I.R.C. 731. The intricacies of partnership allocations are beyond the scope of this article; however, allocations cannot be made arbitrarily and must have substantial economic e ect. I.R.C. 704(b); Treas. Reg. 1.704-1(b); Rev. Rul. 92-97; Rev. Rul. 94-4. 25 The exclusions are generally conditioned upon the taxpayer giving up certain tax bene ts. 26 The exclusion from gross income associated with Section 108 is not free. For each dollar of exclusion claimed by the taxpayer because of any exclusion (except real property business indebtedness and under Section 108(i)), the taxpayer must also give up a dollar of tax attributes or reduce the basis of his/her depreciable property. I.R.C. 108(b)(1). This, in e ect, protects the tax payer from the inclusion of COD income in the present, but will lead to a larger gain on sale in the future. 27 I.R.C. 108(a)(1)(A), (d)(6). 28 I.R.C. 108(d)(6). 29 I.R.C. 108(d)(6); Brickman v. C.I.R., T.C. Memo. 1998-340, T.C.M. (RIA) P 98340, 76 T.C.M. (CCH) 506 (1998). However, note, that if the entity were taxed as a corporation (including an S-corp.), the bankruptcy exclusion could be used at the entity level. 30 I.R.C. 108. 31 Gracia v. C.I.R., T.C. Memo. 2004-147, T.C.M. (RIA) P 2004-147, 87 T.C.M. (CCH) 1423 (2004). 32 Gracia, T.C. Memo. 2004-147. 33 Contrast the Gracia decision with Yamamoto v. C.I.R., T.C. Memo. 1990-549, T.C.M. (P-H) P 90549, 60 T.C.M. (CCH) 1050, 1990 WL 159235 (1990), a 'd, 958 F.2d 380 (9th Cir. 1992) (stating, in dicta, that the structure and legislative history of 108 make clear that the bankruptcy exclusion provides tax relief to the debtor in bankruptcy and not to the debtor of the debtor in bankruptcy). 34 I.R.C. 108(a)(1)(B). 35 I.R.C. 108(d)(6). 36 I.R.C. 108(d)(3); Carlson v. C.I.R., 116 T.C. 87, Tax Ct. Rep. Dec. (RIA) 116.9, 2001 WL 180173 (2001). 37 Carlson v. C.I.R., 116 T.C. 87, 105, Tax Ct. Rep. Dec. (RIA) 116.9, 2001 WL 180173 (2001); see, also, Shepherd v. C.I.R., T.C. Memo. 2012-212, T.C.M. (RIA) P 2012-212, 104 T.C.M. (CCH) 108 (2012). 38 Shepherd, T.C. Memo. 2012-212. 39 I.R.C. 108(a)(3) (the amount of COD income in excess of the amount of the insolvency is not excludable). 40 I.R.C. 108(a)(1)(D); C-Corporation taxpayers are speci cally excluded. 41 I.R.C. 108(c)(3). 42 I.R.C. 108(c)(4). 43 I.R.C. 108(c)(2)(B). 44 Reg. 1.108-6, 1.1017-1(c)(1). 11

The Real Estate Finance Journal 45 H.R. Rep. No. 103-11 at 438 (1993). 46 For the purposes of this example, neither debt is quali ed farm indebtedness as quali ed farm indebtedness is speci cally excluded from the quali ed real property business indebtedness de nition, I.R.C. 108(c)(3). 47 I.R.C. 1017; Treas. Reg. 1.1017-1. 48 H.R. Rep. No. 103-11 at 438 (1993). 49 H.R. Rep. No. 103-11 at 438 to 439 50 H.R. Rep. No. 103-11 at 439 51 Pub. L. No. 111-5, 123 Stat. 338, American Recovery and Reinvestment Tax Act of 2009 Section 1231. 52 I.R.C. 108(i)(1). 53 The deferral of the COD income, however, is accelerated and recognized as income in the year the partner dies, the entity liquidates, the entity sells substantially all of its assets or ceases to do business, or a sale/exchange or redemption of the partnership interest. I.R.C. 108(i)(4)(D). 54 I.R.C. 108(i)(5)(C). 55 I.R.C. 704. 56 For purposes of I.R.C. 752. 57 Under I.R.C. 731, 108(i)(6). 58 This article is intended only as a general discussion of the issues described herein, and it does not constitute legal advice. Professional advice should be sought for speci c solutions. This article is not intended to create, and does not create, an attorney-client relationship.irc Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in or accompanying this document, unless otherwise speci cally stated, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in or accompanying this document. 12