Section 108 of the I.R.C. and the Inclusion of Tufts Gain: A Proposal for Reform

Abstract

The 1983 U.S. Supreme Court decision in Commissioner v Tufts established the modern rule that requires a taxpayer to include the full amount of a nonrecourse note in the amount realized on the disposition of a property, notwithstanding the fair market value of the property. Although not fully understood at the time, this holding has had a large impact on the ability of a financially troubled debtor to defer cancellation of indebtedness income under § 108 of the Internal Revenue Code. Presently, § 108 allows a borrower who is insolvent or in a title 11 bankruptcy proceeding to defer the recognition of COD income, rather than recognize it as a gain. Under Tufts, when a property is transferred with a fairmarket value below the nonrecourse debt used to purchase the assPt, the taxpayer realizes a non-deferrable gain to the extent of the difference between the fair-market value of the property and the taxpayer's basis in the property. This Note argues that the Internal Revenue Service's treatment of nonrecourse debt and its application to § 108 is unworkable. By allowing an insolvent taxpayer to defer COD income while not allowing an identical taxpayer to defer gain from the discharge of indebtedness, the Service has disregarded the statutory purpose of § 108 and has violated the fundamental principles of equity and fairness in the administration of our tax system.