[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: 26CFR1.61-12]

[Page 46-47]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.61-12  Income from discharge of indebtedness.

    (a) In general. The discharge of indebtedness, in whole or in part, 
may result in the realization of income. If, for example, an individual 
performs services for a creditor, who in consideration thereof cancels 
the debt, the debtor realizes income in the amount of the debt as 
compensation for his services. A taxpayer may realize income by the 
payment or purchase of his obligations at less than their face value. In 
general, if a shareholder in a corporation which is indebted to him 
gratuitously forgives the debt, the transaction amounts to a 
contribution to the capital of the corporation to the extent of the 
principal of the debt.
    (b) Proceedings under Bankruptcy Act. (1) Income is not realized by 
a taxpayer by virtue of the discharge, under section 14 of the 
Bankruptcy Act (11 U.S.C. 32), of his indebtedness as the result of an 
adjudication in bankruptcy, or by virtue of an agreement among his 
creditors not consummated under any provision of the Bankruptcy Act, if 
immediately thereafter the taxpayer's liabilities exceed the value of 
his assets. Furthermore, unless one of the principal purposes of seeking 
a confirmation under the Bankruptcy Act is the avoidance of income tax, 
income is not realized by a taxpayer in the case of a cancellation or 
reduction of his indebtedness under--
    (i) A plan of corporate reorganization confirmed under Chapter X of 
the Bankruptcy Act (11 U.S.C., ch. 10);
    (ii) An ``arrangement'' or a ``real property arrangement'' confirmed 
under Chapter XI or XII, respectively, of the Bankruptcy Act (11 U.S.C., 
ch. 11, 12); or
    (iii) A ``wage earner's plan'' confirmed under Chapter XIII of the 
Bankruptcy Act (11 U.S.C., ch. 13).
    (2) For adjustment of basis of certain property in the case of 
cancellation or reduction of indebtedness resulting from a proceeding 
under the Bankruptcy Act, see the regulations under section 1016.
    (c) Issuance and repurchase of debt instruments--(1) Issuance. An 
issuer does not realize gain or loss upon the issuance of a debt 
instrument. For rules relating to an issuer's interest deduction for a 
debt instrument issued with bond issuance premium, see Sec. 1.163-13.
    (2) Repurchase--(i) In general. An issuer does not realize gain or 
loss upon the repurchase of a debt instrument. However, if a debt 
instrument provides for payments denominated in, or determined by 
reference to, a nonfunctional currency, an issuer may realize a currency 
gain or loss upon the repurchase of the instrument. See section 988 and 
the regulations thereunder. For purposes of this paragraph (c)(2), the 
term repurchase includes the retirement of a debt instrument, the 
conversion of a debt instrument into stock of the issuer, and the 
exchange (including an exchange under section 1001) of a newly issued 
debt instrument for an existing debt instrument.
    (ii) Repurchase at a discount. An issuer realizes income from the 
discharge of indebtedness upon the repurchase of a debt instrument for 
an amount less than its adjusted issue price (within the meaning of 
Sec. 1.1275-1(b)). The amount of discharge of indebtedness income is 
equal to the excess of the adjusted issue price over the repurchase 
price. See section 108 and the regulations thereunder for additional 
rules relating to income from discharge of indebtedness. For example, to 
determine the repurchase price

[[Page 47]]

of a debt instrument that is repurchased through the issuance of a new 
debt instrument, see section 108(e)(10).
    (iii) Repurchase at a premium. An issuer may be entitled to a 
repurchase premium deduction upon the repurchase of a debt instrument 
for an amount greater than its adjusted issue price (within the meaning 
of Sec. 1.1275-1(b)). See Sec. 1.163-7(c) for the treatment of 
repurchase premium.
    (iv) Effective date. This paragraph (c)(2) applies to debt 
instruments repurchased on or after March 2, 1998.
    (d) Cross references. For exclusion from gross income of--
    (1) Income from discharge of indebtedness in certain cases, see 
sections 108 and 1017, and regulations thereunder;
    (2) Forgiveness of Government payments to encourage exploration, 
development, and mining for defense purposes, see section 621 and 
regulations thereunder.
    (e) Cross reference. For rules relating to the treatment of 
liabilities on the sale or other disposition of encumbered property, see 
Sec. 1.1001-2.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6984, 33 FR 
19174, Dec. 24, 1968; T.D. 7741, 45 FR 81745, Dec. 12, 1980; T.D. 8746, 
62 FR 68175, Dec. 31, 1997]