Hussey v. Commissioner
156 T.C. No. 12

On June 24, 2021, the Tax Court issued its opinion in Hussey v. Commissioner (156 T.C. No. 12). The primary issues presented in Hussey v. Commissioner were whether the petitioner was required to reduce his bases in disposed depreciable real properties immediately before sales of those properties in year of discharge of qualified real property business indebtedness (QRPBI), rather than in subsequent year; whether the taxpayer had discharge of indebtedness income; and whether the taxpayer had reasonable cause to avoid accuracy related penalties.

Background of Hussey v. Commissioner

In 2012 the petitioner received a discharge of qualified real property business indebtedness (QRPBI). The discharge of QRPBI may be excluded from income if the taxpayer’s bases in depreciable real properties are reduced by the amount of the debt discharge. IRC § 108(a)(1)(D), (c)(1). A basis reduction occurs only to the extent that the taxpayer’s aggregate bases in depreciable real properties equal or exceed the amount of debt discharged. IRC § 108(c)(2)(B). The petitioner’s aggregated bases exceeded the amount of QRPBI in 2012.

The basis reduction generally occurs in the year following the discharge of indebtedness. IRC § 1017(a). However, as an exception to that general rule, the basis reduction for discharge of QRPBI occurs in the same year as the sale of “property taken into account under IRC § 108(c)(2)(B).” IRC § 1017(b)(3)(F)(iii). Thus, the basis reduction occurs in the year the debt is discharged if the taxpayer sells (in the same year as the discharge) the depreciable real property that had been used to prove the taxpayer had aggregated bases that exceeded the discharge amount.

The petitioner’s Form 1040X for 2012 and his Forms 1040 for the years at issue, 2013 and 2014, were prepared by a tax law firm to which the petitioner was referred with the assistance of his long-time financial adviser and a large accounting firm. The parties dispute how provisions relating to the timing of the basis adjustment for discharge of QRPBI in IRC § 108 and IRC § 1017 apply; whether the lending bank discharged any of the petitioner’s debt in 2013; and whether the petitioner is liable for accuracy-related penalties for 2013 and 2014.

Reduction of Basis

IRC § 61(a)(10) and IRC § 108(a)(1)(D) provide an exclusion from income for forgiveness of QRPBI. When that exclusion applies, the taxpayer must reduce his or her bases in the depreciable real properties. IRC § 108(c)(1). The parties agreed that the petitioner’s indebtedness on the 15 investment properties sold short in 2012 was QRPBI. See IRC § 108(c)(1).

The parties also agree that petitioner may exclude the discharge of his QRPBI from income. See IRC § 61(a)(10); IRC § 108(a)(1)(D). Finally, the parties agree that petitioner must reduce his bases in the depreciable real properties as a result of that exclusion. See IRC § 108(c)(1). The parties dispute the year for which the basis reductions must be made. Petitioner contended that the basis reductions must be made for 2013. The IRS contended they must be made for 2012.

IRC § 1017 states generally that basis reductions resulting from the discharge of QRPBI are made the year after the debt is discharged. If IRC § 1017(a) applies here, the basis adjustments at issue would, as petitioner contends, be made in 2013. However, IRC § 1017(b)(3)(F) provides three additional rules which govern reduction of basis following discharge of QRPBI. First, real property, the aggregate bases of which are considered under IRC § 108(c)(2)(B), includes only depreciable real property. IRC § 1017(b)(3)(F)(i). Second, the depreciable real property may not be held as inventory. IRC § 1017(b)(3)(F)(ii).

Third, IRC § 1017(b)(3)(F)(iii) provides that, in the case of “property taken into account under IRC § 108(c)(2)(B), the [basis] reduction with respect to such property shall be made as of the time immediately before [the] disposition if earlier than the time under” IRC § 1017(a) (i.e., the year following the discharge). Application of this third rule requires consideration of whether “property [was] taken into account under IRC § 108(c)(2)(B);” and if it was, then the “reduction with respect to such property shall be made as of the time immediately before [the] disposition [e.g., sale] if earlier than the time under” IRC § 1017(a).

Thus, the Tax Court was left to decide whether, as stated in the third rule, IRC § 1017(b)(3)(F)(iii), property was taken into account under IRC § 108(c)(2)(B).

The amount of discharged QRPBI excluded from a taxpayer’s income may not exceed the aggregate bases of the taxpayer’s depreciable real properties held immediately before the discharge. IRC § 108(c)(2)(B). IRC § 1017(b)(3)(F)(iii) also provides that in the case of “property taken into account under IRC § 108(c)(2)(B)” (i.e., depreciable real property which was used to show that he had aggregated bases in excess of the discharge amount) in the same year as the discharge, the basis reductions must occur immediately before the sales of the properties and not in the year following the sales.

Because in 2012 petitioner (1) received a discharge of QRPBI and (2) sold properties the bases of which were used to show he had aggregated bases that exceed the discharge amount, he was required to reduce his bases in the disposed properties immediately before the sales of those properties in 2012, not in 2013. His reported bases for the properties sold in 2012 should have reflected these reductions, and any remaining reductions should have been reflected in the bases of his remaining properties for 2013.

(156 T.C. No. 12) Hussey v. Commissioner

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