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2. Discharge of Indebtedness Income
Dove Canyon made a profit from its activities in its first
years. Later, a downturn in the California real estate market,
inflation, and increased interest costs resulted in significant
losses on the project. In 1992 and 1993, banks forgave a
substantial amount of debt owed by Dove Canyon. Thus, Dove
Canyon realized $20,345,080 in discharge of indebtedness income
in 1992 and $11,887,728 in 1993. Cost overruns and a decline in
real estate values caused Dove Canyon's debts to exceed the value
of its assets. The income from discharge of indebtedness was
included in Dove Canyon's taxable income since, in the case of
partnerships, the insolvency exception applies at the partner
level. See sec. 108(a)(1)(B), (d)(6).
Mikama's allocable share of discharge of indebtedness income
from Dove Canyon was $2,034,508 for 1992 and $1,188,773 for 1993.
In 1992, Mikama excluded $2,034,508 from gross income under
section 108(a)(1)(B). In 1993, Mikama excluded $952,600 from
gross income because section 108(a)(3) limits the section
108(a)(1)(B) exclusion to the amount by which the taxpayer is
insolvent.
Mikama's assets in 1992 and 1993 were its partnership
interest in Dove Canyon and a small amount of cash. Mikama had
cash before the discharge of indebtedness of $1,900 in 1992 and
$1,100 in 1993.
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Last modified: May 25, 2011