The IRS has provided a safe harbor that will treat indebtedness secured by 100 percent of an ownership interest in a disregarded entity holding real property as indebtedness that is secured by real property under Code Sec. 108(c)(3)(A). This guidance applies to discharge of indebtedness of any taxpayer provided the requirements are satisfied. Those requirements are:
(1) the taxpayer or a wholly owned disregarded entity of the borrower incurs indebtedness;
(2) the borrower directly or indirectly owns 100 percent of the ownership interest in a separate disregarded entity owning real property and the borrower is not the same entity as the property owner;
(3) the borrower pledges to the lender a first-priority security interest in the borrower’s ownership in the property owner and any encumbrance on the pledged ownership interest must be subordinate to the lender’s security interest in the property owner;
(4) at least 90 percent of the fair market value of the total assets directly owned by the property owner must be real property used in a trade or business and any other assets held by the property owner must be incidental to the acquisition, ownership, and operation of the real property; and
(5) upon default and foreclosure on the indebtedness, the lender will replace the borrower as the sole member of the property owner.
The guidance is effective for taxpayers who make an election under Code Sec. 108(c)(3) regarding discharged indebtedness on or after February 5, 2014.
Rev. Proc. 2014-20, 2014FED ¶46,257
Code Sec. 108
CCH Reference – 2014FED ¶7010.32
CCH Reference – 2014FED ¶7010.38
Tax Research Consultant
CCH Reference – TRC NOL: 27,052