Volume 5 Winter 2011 Number 2 - Charleston Law Review

2011] Tax Aspects—Financially Troubled Entitiesthe partnership agreement. 113 On the other hand, one mightargue that a fairer result would be to allocate the cancellation ofindebtedness income back to the partners based on the samepercentage in which they share the debt. There is no specificstatutory rule that covers this case. The answer, as discussed ina revenue ruling, turns on whether the allocation has substantialeconomic effect under § 704 and the regulations within thatsection. 114Revenue Ruling 92-97 relates to a hypothetical case in whichpartners A and B form a general partnership, and A contributes$10x and B contributes $90x to the AB Partnership. 115 Thepartners share profits equally, but losses are allocated 10% to Aand 90% to B. 116 The partnership uses the $100x and $900x inloan proceeds to acquire property for $1,000x. $90x of the debt isallocated to A, and the remaining $810x is allocated to Bpursuant to the rules governing § 752. 117 After five years thepartnership breaks even, and the property is fully depreciated.However, the property’s value has declined so greatly that thelender cancels the debt. Depreciation deductions are allocated10% to A and 90% to B. Although the partners agreed toliquidate based on the positive capital account balances, thepartnership agreement did not provide for an unconditionaldeficit restoration obligation. The partners are required torestore deficit capital accounts only to the extent that it isnecessary to pay creditors. Neither partner has an obligation tomake a contribution to satisfy the other partner’s positive capitalaccount upon liquidation.Based on the foregoing facts, A has a negative capital accountof $90x, and B has a negative capital account of $810. As a resultof the debt cancellation, the partners are not obligated to restoretheir deficit capital accounts. Because the debt is cancelled, bothpartners will receive a deemed distribution of money equal to$90x in A’s case and $810x in B’s case.113. I.R.C. § 702(a)(8) (2006).114. I.R.C. § 704(b)(2).115. Rev. Rul. 92-97, 1992-2 C.B. 124.116. Id.117. Id.251