Volume 5 Winter 2011 Number 2 - Charleston Law Review

CHARLESTON LAW REVIEW [Volume 5§ 1001 addressing when a modification of a debt instrument willresult in a taxable exchange for purposes of Treas. Reg. § 1.1001-1(a).The material debt modification rules apply to an exchange ofan existing debt instrument for a new debt instrument, to anamendment of an existing debt instrument, or to indirecttransactions involving the issuer and holder that are effectuatedthrough transactions with third parties. 4 The regulations coverfive specific situations that could determine whether a significantmodification arises. The five situations are: (A) changes in obligoror security; (B) changes in the yield of a debt instrument; (C)changes in timing of payments; (D) an alteration in the nature orcharacterization of the instrument; and (E) changes inaccounting or financial covenants. 5A. Changes in Obligor or SecuritySubject to a limited number of exceptions, the substitution ofa new obligor on a recourse debt instrument constitutes asignificant modification. 6 The exceptions to the recourse rule are:(a) the new obligor is an acquiring corporation within themeaning of § 381 and the transaction does not result in a changein prepayment expectations; (b) the new obligor acquiressubstantially all of the assets of the original debtor and there isno change in prepayment expectations; and (c) the substitution ofa new obligor on a tax-exempt bond, where the new obligor isrelated to the original obligor and the collateral associated withthe transaction continues to include the original collateral. 7 Theregulations provide that a substitution “on a nonrecourse debtinstrument is not a significant modification.” 8With respect to changes in security or credit enhancement, amodification is substantial only if there is a change inprepayment expectations. 9 The general rule for nonrecourse debt2324. Treas. Reg. § 1.1001-3(a) (2009).5. § 1.1001-3(e).6. § 1.1001-3(e)(4)(i)(A).7. § 1.1001-3(e)(4)(i)(B)(D).8. § 1.1001-3(e)(4)(ii).9. § 1.1001-3(e)(4)(iv)(A).