Tax Court rules debt cancellation part of sale realization


he Tax Court has held in Parker v. Commissioner (T.C. Memo 2023-104) that an S corporation’s cancellation of nonrecourse debt should be included in the amount realized on the sale of property and is not cancellation of debt (COD) income.


In Parker, an S corporation (Exterra) was wholly owned by an individual (Parker). Exterra held single member LLCs that were treated as disregarded entities (DREs) for federal income tax purposes.


In March 2007, Exterra purchased, through its DREs, a real estate development property in Livermore, Calif. (the “Livermore property”). The purchase was financed with a nonrecourse loan from an unrelated third-party lender, NRFC WA Holdings, LLC (“NRFC”).  Mr. Parker personally guaranteed payment on the third-party loans. In addition, two of the loans were secured by the membership interests in two of Exterra’s DREs (the “Montevina entities”).


In 2012, Exterra sold the Livermore property to third-party buyers. As part of the sale, membership interests in the Montevina entities were also sold to the buyers. The buyers also agreed to assume the personal guaranty obligation loans to NRFC. Exterra realized $40,585,539 upon the assumption of nonrecourse debt by the buyers and $12,698,829 from the debt cancelled by NRFC.


Exterra’s originally filed a return reporting $53,284,369 in gross receipts related to the debt assumed by the buyers and debt cancelled by NRFC. After netting the gross receipts against cost of goods sold and other deductions, Exterra reported $2,741,399 of ordinary business income. Exterra later amended its return to reduce its gross receipts from the Livermore sale by $2,741,399, and instead report that amount as COD income that could be excluded under the insolvency exception of Section 108(a)(1)(B) because Exterra and Mr. Parker were both insolvent at the time of the cancellation of debt. 


The Tax Court held that the Livermore property was encumbered by nonrecourse debt and the outstanding debt should be included in the amount realized under Commissioner v. Tufts (461 U.S. 300 (1983)) and Crane v. Commissioner (331 U.S. 1 (1947)). Under Section 1001(a), Exterra recognized gain to the extent the amount realized exceeded its adjusted basis in the Livermore property. The Court’s decision was based on the fact that the cancellation of the debt was conditioned upon the sale of the Livermore property citing 2925 Briarpark, Ltd. V. Commissioner (163 F. 3d 313 (5th Cir. 1999)).


The Court held that the insolvency exception can only be applied after establishing that COD income exists, and the cancellation did not result in COD income under Section 61(a)(12).



Tax professional standards statement

This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.


More tax hot topics