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4. Petitioner’s Purchase of Its Debt Obligations
Would Result in Discharge of Indebtedness Income
Respondent appears to argue that the only way petitioner
could realize the value of favorable financing would be to buy
back its debt instruments at their discounted market prices.
Respondent claims that this is impractical because petitioner
would incur tax on the resulting discharge of indebtedness
income.
When a taxpayer repays a debt at a discount, the taxpayer
normally realizes income from the discharge of indebtedness. See
sec. 61(a)(12); United States v. Kirby Lumber Co., 284 U.S. 1, 3
(1931). Section 1.61-12(a), Income Tax Regs., provides that “The
discharge of indebtedness, in whole or in part, may result in the
realization of income. * * * A taxpayer may realize income by
the payment or purchase of his obligations at less than their
face value.” When a taxpayer receives borrowed funds, those
funds are excluded from income because the taxpayer has an
obligation to repay the funds. United States v. Centennial Sav.
Bank FSB, 499 U.S. 573, 582 (1991). The rationale for including
discharge of indebtedness in a taxpayer’s income is that the
taxpayer “realizes an accession to income due to the freeing of
assets previously offset by the liability.” Jelle v.
Commissioner, 116 T.C. 63, 67 (2001) (citing United States v.
Kirby Lumber Co., supra at 3).
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