§1017 Discharge of Indebtedness

Summary

When part of a canceled debt is excluded from income but some of that excluded amount must be used to lower the cost (basis) of your property, the Treasury will make rules saying how much to reduce and which properties to lower. If the debt discharge is the kind in 108(a)(1)(A) or (B), the total basis cut cannot be more than the total bases of your property after the discharge minus your total liabilities after the discharge. Some specified amounts must be used only to lower the basis of depreciable property. Depreciable property means property you can take depreciation on and only counts if lowering the basis will reduce the next period’s depreciation or amortization. A partner’s share of partnership depreciable property counts to the same extent as the partner’s share, but only if the partnership’s basis is reduced too. If a corporation owns stock in a subsidiary and they file a consolidated return, special rules apply. A taxpayer may elect on the tax return to treat certain real property (see section 1221(a)(1)) as depreciable; that election is filed on the return for the year of the discharge and can be revoked only with the Secretary’s consent. For certain other kinds of excluded amounts, only depreciable real property is covered, the election above does not apply, and reductions may be made right before a disposition if that comes first. If an excluded amount is tied to the special rule for farm or similar property, it must lower the basis only of “qualified property” (the type defined in section 108(g)(3)(C)). Those reductions must be made in this order: first qualified property that is depreciable, then farm land used in the business, then other qualified property. Property you treat as bankruptcy-exempt under 11 U.S.C. 522 does not get its basis reduced. A basis reduction is not treated as if you sold the property. For depreciation recapture rules, property whose basis is reduced may be treated as section 1245 property, the reduction is treated like a depreciation deduction, and for certain straight-line calculations you figure what would have happened as if the basis had not been reduced.