[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.108-7T]

[Page 477-478]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.108-7T  Reduction of attributes (temporary).

    (a) In general. (1) If a taxpayer excludes discharge of indebtedness 
income (COD income) from gross income under section 108(a)(1)(A), (B), 
or (C), then the amount excluded shall be applied to reduce the 
following tax attributes of the taxpayer in the following order:
    (i) Net operating losses.
    (ii) General business credits.
    (iii) Minimum tax credits.
    (iv) Capital loss carryovers.
    (v) Basis of property.
    (vi) Passive activity loss and credit carryovers.
    (vii) Foreign tax credit carryovers.
    (2) The taxpayer may elect under section 108(b)(5), however, to 
apply any portion of the excluded COD income to reduce first the basis 
of depreciable property. To the extent the excluded COD income is not so 
applied, the taxpayer must then reduce any remaining tax attributes in 
the order specified in section 108(b)(2). If the excluded COD income 
exceeds the sum of the taxpayer's tax attributes, the excess is 
permanently excluded from the taxpayer's gross income. For rules 
relating to basis reductions required by sections 108(b)(2)(E) and 
108(b)(5), see sections 1017 and 1.1017-1. For rules relating to the 
time and manner for making an election under section 108(b)(5), see 
Sec. 1.108-4.
    (b) Carryovers and carrybacks. The tax attributes subject to 
reduction under section 108(b)(2) and paragraph (a)(1) of this section 
that are carryovers to the taxable year of the discharge, or that may be 
carried back to taxable years preceding the year of the discharge, are 
taken into account by the taxpayer for the taxable year of the discharge 
or the preceding years, as the case may be, before such attributes are 
reduced pursuant to section 108(b)(2) and paragraph (a)(1) of this 
section.
    (c) Transactions to which section 381 applies. In the case of a 
transaction described in section 381(a) that ends a taxable year in 
which the distributor or transferor corporation excludes COD income 
under section 108(a), any tax attributes to which the acquiring 
corporation succeeds and the basis of property acquired by the acquiring 
corporation in the transaction shall reflect the reductions required by 
section 108(b). For this purpose, all attributes listed in section 
108(b)(2) of the distributor or transferor corporation immediately prior 
to the transaction described in section 381(a), but after the 
determination of tax for the year of the discharge, including basis of 
property, shall be available for reduction under section 108(b)(2).
    (d) Examples. The following examples illustrate the application of 
this section:

    Example 1. (i) Facts. In Year 4, X, a corporation in a title 11 
case, is entitled under section 108(a)(1)(A) to exclude from gross 
income $100,000 of COD income. For Year 4, X has gross income in the 
amount of $50,000. In each of Years 1 and 2, X had no taxable income or 
loss. In Year 3, X had a net operating loss of $100,000, the use of 
which when carried over to Year 4 is not subject to any restrictions 
other than those of section 172.

[[Page 478]]

    (ii) Analysis. Pursuant to paragraph (b) of this section, X takes 
into account the net operating loss carryover from Year 3 in computing 
its taxable income for Year 4 before any portion of the COD income 
excluded under section 108(a)(1)(A) is applied to reduce tax attributes. 
Thus, the amount of the net operating loss carryover that is reduced 
under section 108(b)(2) and paragraph (a) of this section is $50,000.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that in Year 4 X sustains a net operating loss in the amount of 
$100,000. In addition, in each of Years 2 and 3, X reported taxable 
income in the amount of $25,000.
    (ii) Analysis. Pursuant to paragraph (b) of this section and section 
172, the net operating loss sustained in Year 4 is carried back to Years 
2 and 3 before any portion of the COD income excluded under section 
108(a)(1)(A) is applied to reduce tax attributes. Thus, the amount of 
the net operating loss that is reduced under section 108(b)(2) and 
paragraph (a) of this section is $50,000.
    Example 3. (i) Facts. In Year 2, X, a corporation in a title 11 
case, has outstanding debts of $200,000 and a depreciable asset that has 
an adjusted basis of $75,000 and a fair market value of $100,000. X has 
no other assets or liabilities. X has a net operating loss of $80,000 
that is carried over to Year 2 but has no general business credit, 
minimum tax credit, or capital loss carryovers. Under a plan of 
reorganization, X transfers its asset to Corporation Y in exchange for Y 
stock with a value of $100,000. X distributes the Y stock to its 
creditors in exchange for release of their claims against X. X's 
shareholders receive nothing in the transaction. The transaction 
qualifies as a reorganization under section 368(a)(1)(G) that satisfies 
the requirements of section 354(b)(1)(A) and (B). For Year 2, X has 
gross income of $10,000 (without regard to any income from the discharge 
of indebtedness) and is allowed a depreciation deduction of $10,000 in 
respect of the asset. In addition, it generates no general business 
credits.
    (ii) Analysis. On the distribution of Y stock to X's creditors, 
under section 108(a)(1)(A), X is entitled to exclude from gross income 
the debt discharge amount of $100,000. (Under section 108(e)(8), X is 
treated as satisfying $100,000 of the debt owed the creditors for 
$100,000, the fair market value of the Y stock transferred to those 
creditors.) In Year 2, X has no taxable income or loss because its gross 
income is exactly offset by the depreciation deduction. As a result of 
the depreciation deduction, X's basis in the asset is reduced by $10,000 
to $65,000. Pursuant to paragraph (c) of this section, the amount of X's 
net operating loss to which Y succeeds pursuant to section 381 and the 
basis of X's property transferred to Y must take into account the 
reductions required by section 108(b). Pursuant to paragraph (a) of this 
section, X's net operating loss carryover in the amount of $80,000 is 
reduced by $80,000 of the COD income excluded under section 108(a)(1). 
In addition, X's basis in the asset is reduced by $20,000, the extent to 
which the COD income excluded under section 108(a)(1) did not reduce the 
net operating loss. Accordingly, as a result of the reorganization, 
there is no net operating loss to which Y succeeds under section 381. 
Pursuant to section 361, X recognizes no gain or loss on the transfer of 
its property to Y. Pursuant to section 362(b), Y's basis in the asset 
acquired from X is $45,000.
    Example 4. (i) Facts. The facts are the same as in Example 3, except 
that X elects under section 108(b)(5) to reduce first the basis of its 
depreciable asset.
    (ii) Analysis. As in Example 3, on the distribution of Y stock to 
X's creditors, under section 108(a)(1)(A), X is entitled to exclude from 
gross income the debt discharge amount of $100,000. In addition, in Year 
2, X has no taxable income or loss because its gross income is exactly 
offset by the depreciation deduction. As a result of the depreciation 
deduction, X's basis in the asset is reduced by $10,000 to $65,000. 
Pursuant to paragraph (c) of this section, the amount of X's net 
operating loss to which Y succeeds pursuant to section 381 and the basis 
of X's property transferred to Y must take into account the reductions 
required by section 108(b). As a result of the election under section 
108(b)(5), X's basis in the asset is reduced by $65,000 to $0. In 
addition, X's net operating loss is reduced by $35,000, the extent to 
which the amount excluded from income under section 108(a)(1)(A) does 
not reduce X's asset basis. Accordingly, as a result of the 
reorganization, Y succeeds to X's net operating loss in the amount of 
$45,000 under section 381. Pursuant to section 361, X recognizes no gain 
or loss on the transfer of its property to Y. Pursuant to section 
362(b), Y's basis in the asset acquired from X is $0.

    (e) Effective date. This section applies to discharges of 
indebtedness occurring after July 17, 2003.

[T.D. 9080, 68 FR 42592, July 18, 2003; 68 FR 56556, Oct. 1, 2003]