Volume 5 Winter 2011 Number 2 - Charleston Law Review

2011] Tax Aspects—Financially Troubled Entitiespartnership taxable year. 58 Thus, the reduction in basistriggered by the cancellation of indebtedness income can beutilized as an offset against the basis increase occasioned by thebasis step up attributable to the cancellation of indebtednessincome.If a partner’s distributive share of cancellation ofindebtedness income is in the same proportion as his share ofliabilities, then the amount of the basis step up concerning thecancellation of indebtedness income will exactly offset the declinein partnership debt. However, the partner will still havecancellation of indebtedness income to include as taxable income.If the percentages are not shared in the same proportions, then apartner can pick up gain as well as be taxed on cancellation ofindebtedness income.B. Publicly Traded Debt vs. Non-Publicly Traded DebtThe determination of the issue price is based on whether thenew debt is publicly traded or non-publicly traded. 59 However, asa practical matter, the vast majority of cases will involve nonpubliclytraded debt instruments.Where new publicly traded debt instruments are issued inexchange for publicly traded debt instruments that have beensubjected to a “significant modification,” the issue price of thenew debt instruments equates to the fair market value of the olddebt instrument. 60 This transaction places the debtor on a markto-marketrule. Assume for example that the old debt has aprincipal amount of $1,000,000 and a fair market value of$900,000. Further assume a substantial modification by way ofdeferral of payments. The issue price of the new debt is $900,000.Upon the deemed exchange of the old debt instrument for thenew debt instrument, the new instrument has a tax basis of$900,000, the lender realizes a loss of $100,000, and the debtorrealizes cancellation of indebtedness income of the same amount.58. Rev. Rul. 94-4, 1994-1 C.B. 195.59. I.R.C. §§ 1273–1274.60. I.R.C. § 1273(b)(3).241