- 47 -
income for petitioner, because the discharge effects a freeing of
assets previously offset by the liability arising from that loan,
then it necessarily follows that petitioner's liability on the
Miller/Huntington debt was not contingent and is to be treated as
in existence immediately before the discharge.32
We therefore agree with petitioners that the $1,375,000
balance on the Miller/Huntington Loan as of December 29, 1994,
should be counted as a liability in determining whether petitioner
was insolvent when the discharge occurred, which results in
insolvency on that date to the extent of $1,102,000.
As the amount of petitioner's insolvency exceeds $900,000, the
entire amount of the discharge of indebtedness income is excluded
32 We recognize that the foregoing analysis applies
principally to the $900,000 portion of the Miller/Huntington Loan
that respondent contends was discharged for purposes of sec.
61(a)(12) in 1994. However, petitioner's liability under the
remaining $475,000 portion of the Miller/Huntington Loan, which
was purchased by the Rapp Group on Dec. 29, 1994, satisfies the
standard set forth in Merkel v. Commissioner, 109 T.C. 463, 484
(1997), for recognizing a liability for purposes of the
insolvency exception, because it was more probable than not,
immediately before the discharge, that petitioner would be called
upon to pay that obligation in the stated amount.
We reach this conclusion based on the following: (i) The
Rapp Group purchased $475,000 of the Miller/Huntington Loan
(thereby becoming petitioner's creditors rather than guarantors)
because it was anticipated that the completion of MMS's
outstanding contracts, plus the liquidation of its assets, would
result in proceeds of approximately this amount; (ii) petitioner
formed a new entity with the Rapp Group, to which MMS's assets
and outstanding contracts were transferred, for the purpose of
completing MMS's contracts; and (iii) the $475,000 portion of the
indebtedness was in fact subsequently satisfied with such
contract proceeds and asset liquidation.
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