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The shareholder’s basis, once computed, limits the amount of
losses and deductions that may be taken into account by a
shareholder for the taxable year. Sec. 1366(d).
In memoranda filed with the Court prior to the hearing on
these matters, several arguments were set forth in support of
respondent's motions, including the argument that discharge of
indebtedness income was “deferred” and not “tax-exempt income”
under section 1366(a). (Respondent did not argue that section
1367(b)(1) precluded an increase in basis with respect to income
from discharge of indebtedness, presumably because, to the extent
at issue here, such income was not required to be included on
petitioners’ returns.) At the hearing on these matters, however,
respondent abandoned those prior arguments and argued the
following position:
If the Court were to hold that excluded COD
[cancellation (discharge) of indebtedness] is an item
of income under Code section 1366, then you would have
to find that it flows through to the taxpayers and they
increase their basis. Respondent's position is that
it's not an item of income and never flows through
* * *
We deal here solely with respondent’s “final” position.
Respondent's position is based on section 1.61-12(a), Income
Tax Regs., which states in part: "The discharge of indebtedness,
in whole or in part, may result in the realization of income",
and on section 1.61-12(b), Income Tax Regs., which states in
part: "Income is not realized by a taxpayer * * * by virtue of
an agreement among his creditors not consummated under any
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