[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1001-2]

[Page 15-17]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1001-2  Discharge of liabilities.

    (a) Inclusion in amount realized--(1) In general. Except as provided 
in paragraph (a) (2) and (3) of this section, the amount realized from a 
sale or other disposition of property includes the amount of liabilities 
from which the transferor is discharged as a result of the sale or 
disposition.
    (2) Discharge of indebtedness. The amount realized on a sale or 
other disposition of property that secures a recourse liability does not 
include amounts that are (or would be if realized and recognized) income 
from the discharge of indebtedness under section 61(a)(12). For 
situations where amounts arising from the discharge of indebtedness are 
not realized and recognized, see section 108 and Sec. 1.61-12(b)(1).
    (3) Liability incurred on acquisition. In the case of a liability 
incurred by reason of the acquisition of the property, this section does 
not apply to the extent that such liability was not taken into account 
in determining the transferor's basis for such property.
    (4) Special rules. For purposes of this section--
    (i) The sale or other disposition of property that secures a 
nonrecourse liability discharges the transferor from the liability;
    (ii) The sale or other disposition of property that secures a 
recourse liability discharges the transferor from the liability if 
another person agrees to pay the liability (whether or not the 
transferor is in fact released from liability);
    (iii) A disposition of property includes a gift of the property or a 
transfer of the property in satisfaction of liabilities to which it is 
subject;
    (iv) Contributions and distributions of property between a partner 
and a partnership are not sales or other dispositions of property; and
    (v) The liabilities from which a transferor is discharged as a 
result of the sale or disposition of a partnership interest include the 
transferor's share of the liabilities of the partnership.
    (b) Effect of fair market value of security. The fair market value 
of the security at the time of sale or disposition is not relevant for 
purposes of determining under paragraph (a) of this section the amount 
of liabilities from which the taxpayer is discharged or treated as 
discharged. Thus, the fact that the fair market value of the property is 
less than the amount of the liabilities it secures does not prevent the 
full amount of those liabilities from being treated as money received 
from the sale or other disposition of the property. However, see 
paragraph (a)(2) of this section for a rule relating to certain income 
from discharge of indebtedness.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples. In each example assume the taxpayer uses the 
cash receipts and disbursements method of accounting, makes a return on 
the basis

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of the calendar year, and sells or disposes of all property which is 
security for a given liability.

    Example 1. In 1976 A purchases an asset for $10,000. A pays the 
seller $1,000 in cash and signs a note payable to the seller for $9,000. 
A is personally liable for repayment with the seller having full 
recourse in the event of default. In addition, the asset which was 
purchased is pledged as security. During the years 1976 and 1977, A 
takes depreciation deductions on the asset in the amount of $3,100. 
During this same time period A reduces the outstanding principal on the 
note to $7,600. At the beginning of 1978 A sells the asset. The buyer 
pays A $1,600 in cash and assumes personal liability for the $7,600 
outstanding liability. A becomes secondarily liable for repayment of the 
liability. A's amount realized is $9,200 ($1,600 + $7,600). Since A's 
adjusted basis in the asset is $6,900 ($10,000 - $3,100) A realizes a 
gain of $2,300 ($9,200 - $6,900).
    Example 2. Assume the same facts as in example (1) except that A is 
not personally liable on the $9,000 note given to the seller and in the 
event of default the seller's only recourse is to the asset. In 
addition, on the sale of the asset by A, the purchaser takes the asset 
subject to the liability. Nevertheless, A's amount realized is $9,200 
and A's gain realized is $2,300 on the sale.
    Example 3. In 1975 L becomes a limited partner in partnership GL. L 
contributes $10,000 in cash to GL and L's distributive share of 
partnership income and loss is 10 percent. L is not entitled to receive 
any guaranteed payments. In 1978 M purchases L's entire interest in 
partnership GL. At the time of the sale L's adjusted basis in the 
partnership interest is $20,000. At that time L's proportionate share of 
liabilities, of which no partner has assumed personal liability, is 
$15,000. M pays $10,000 in cash for L's interest in the partnership. 
Under section 752(d) and this section, L's share of partnership 
liabilities, $15,000, is treated as money received. Accordingly, L's 
amount realized on the sale of the partnership interest is $25,000 
($10,000 + $15,000). L's gain realized on the sale is $5,000 ($25,000 - 
$20,000).
    Example 4. In 1976 B becomes a limited partner in partnership BG. In 
1978 B contributes B's entire interest in BG to a charitable 
organization described in section 170(c). At the time of the 
contribution all of the partnership liabilities are liabilities for 
which neither B nor G has assumed any personal liability and B's 
proportionate share of which is $9,000. The charitable organization does 
not pay any cash or other property to B, but takes the partnership 
interest subject to the $9,000 of liabilities. Assume that the 
contribution is treated as a bargain sale to a charitable organization 
and that under section 1011(b) $3,000 is determined to be the portion of 
B's basis in the partnership interest allocable to the sale. Under 
section 752(d) and this section, the $9,000 of liabilities is treated by 
B as money received, thereby making B's amount realized $9,000. B's gain 
realized is $6,000 ($9,000 - $3,000).
    Example 5. In 1975 C, an individual, creates T, an irrevocable 
trust. Due to certain powers expressly retained by C, T is a ``grantor 
trust'' for purposes of subpart E of part 1 of subchapter J of the code 
and therefore C is treated as the owner of the entire trust. T purchases 
an interest in P, a partnership. C, as owner of T, deducts the 
distributive share of partnership losses attributable to the partnership 
interest held by T. In 1978, when the adjusted basis of the partnership 
interest held by T is $1,200, C renounces the powers previously and 
expressly retained that initially resulted in T being classified as a 
grantor trust. Consequently, T ceases to be a grantor trust and C is no 
longer considered to be the owner of the trust. At the time of the 
renunciation all of P's liabilities are liabilities on which none of the 
partners have assumed any personal liability and the proportionate share 
of which of the interest held by T is $11,000. Since prior to the 
renunciation C was the owner of the entire trust, C was considered the 
owner of all the trust property for Federal income tax purposes, 
including the partnership interest. Since C was considered to be the 
owner of the partnership interest, C not T, was considered to be the 
partner in P during the time T was a ``grantor trust''. However, at the 
time C renounced the powers that gave rise to T's classification as a 
grantor trust, T no longer qualified as a grantor trust with the result 
that C was no longer considered to be the owner of the trust and trust 
property for Federal income tax purposes. Consequently, at that time, C 
is considered to have transferred ownership of the interest in P to T, 
now a separate taxable entity, independent of its grantor C. On the 
transfer, C's share of partnership liabilities ($11,000) is treated as 
money received. Accordingly, C's amount realized is $11,000 and C's gain 
realized is $9,800 ($11,000 - $1,200).
    Example 6. In 1977 D purchases an asset for $7,500. D pays the 
seller $1,500 in cash and signs a note payable to the seller for $6,000. 
D is not personally liable for repayment but pledges as security the 
newly purchased asset. In the event of default, the seller's only 
recourse is to the asset. During the years 1977 and 1978 D takes 
depreciation deductions on the asset totaling $4,200 thereby reducing 
D's basis in the asset to $3,300 ($7,500 - $4,200). In 1979 D transfers 
the asset to a trust which is not a ``grantor trust'' for purposes of 
subpart E of part 1 of subchapter J of the Code. Therefore D is not 
treated as the owner of the trust. The trust takes the asset subject to 
the liability and in addition pays D $750 in cash. Prior to the transfer 
D had reduced the amount outstanding on the

[[Page 17]]

liability to $4,700. D's amount realized on the transfer is $5,450 
($4,700 + $750). Since D's adjusted basis is $3,300, D's gain realized 
is $2,150 ($5,450 - $3,300).
    Example 7. In 1974 E purchases a herd of cattle for breeding 
purposes. The purchase price is $20,000 consisting of $1,000 cash and a 
$19,000 note. E is not personally liable for repayment of the liability 
and the seller's only recourse in the event of default is to the herd of 
cattle. In 1977 E transfers the herd back to the original seller thereby 
satisfying the indebtedness pursuant to a provision in the original 
sales agreement. At the time of the transfer the fair market value of 
the herd is $15,000 and the remaining principal balance on the note is 
$19,000. At that time E's adjusted basis in the herd is $16,500 due to a 
deductible loss incurred when a portion of the herd died as a result of 
disease. As a result of the indebtedness being satisfied, E's amount 
realized is $19,000 notwithstanding the fact that the fair market value 
of the herd was less than $19,000. E's realized gain is $2,500 ($19,000 
- $16,500).
    Example 8. In 1980, F transfers to a creditor an asset with a fair 
market value of $6,000 and the creditor discharges $7,500 of 
indebtedness for which F is personally liable. The amount realized on 
the disposition of the asset is its fair market value ($6,000). In 
addition, F has income from the discharge of indebtedness of $1,500 
($7,500 - $6,000).

[T.D. 7741, 45 FR 81744, Dec. 12, 1980]