Volume 5 Winter 2011 Number 2 - Charleston Law Review

2011] Tax Aspects—Financially Troubled Entities704(c). 92 In other words, a book-up is necessary in order to havecapital accounts that reflect any unrealized appreciation ordepreciation in partnership property. For example, assume thatthe partnership has unrealized appreciation in its assets beforethe exchange of a partnership interest to a creditor insatisfaction of a portion of the partnership debt. Absent a bookup,if the appreciated property is later sold and the appreciationis captured, the existing partners will not receive their propershare of the appreciation.As a general rule, § 706(d) of the Code permits a dailyproration method or an interim-closing-of-the-books methodwhen an interest in a partnership changes during the course of ayear. 93 However, § 108(e)(8)(B) overrides this partnership rule byspecifying that debt discharge income is only allocated to thosewho are partners immediately before the debt discharge. 94 Thisundoubtedly means that only an interim closing is permitted.A. Participation Interest by Creditor Without Change toPartner StatusGiven some of the potential pitfalls in a creditor becoming apartner and taking on liabilities of a partnership, creditors areexploring various ways of securing participation interestswithout having to take on the formal status of a partner. Onepotential way to accomplish this goal is to acquire a contingentinterest in the affairs of the business. This contingent interestmay be based on cash flow or a contingent payout attributable toproceeds generated on the sale of assets. If structured properly,this type of feature should be treated as an interest that givesrise to interest income. One important point for planningpurposes is that one does not wish to effectuate a change thatresults in the reallocation of debt, thereby triggering deemeddistributions under § 731. 9592. Id.93. I.R.C. § 706(d).94. I.R.C. § 108(e)(8)(B).95. I.R.C. § 731.247