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is discharged, the debtor does not realize
COD income to the extent it relates to the Partners & Partnerships Whether partnerships
deferred original issue discount.
Purchase-money debt reduction Navigating partnership terminate or continue
(Sec. 108(e)(5)): If a buyer of property continuations for federal tax
issues a debt instrument to the seller in Transactions between partnerships can
exchange for the property and the seller result in situations where it may be purposes is not
always cut and dried.
subsequently forgives the debt (either in unclear whether any of the partner-
whole or in part), the forgiveness results in ships involved terminate for federal tax
a reduction in the basis of the purchased purposes. Compounding this confusion
property rather than COD income. The is the disconnect between what may
statute states that this exclusion applies occur under state law and the fictional carried on inside CD, which continues
only to solvent debtors not in bankruptcy at series of events deemed to occur for to be owned and operated by A and B.
the time of the COD income event. In the purposes of Subchapter K. These dif- Since the reorganization of AB does not
case of an insolvent or bankrupt partner- ferences can lead to circumstances meet the definition of a termination,
ship, however, the IRS has stated that it will where a partnership may continue to CD should be treated as a continuation
not prevent the partnership from using the exist for tax purposes even when it is of AB. A full-year partnership return is
Sec. 108(e)(5) exclusion, provided that all dissolved under state law. This item filed, as the restructure is disregarded
the partners in the partnership adopt treat- discusses the rules and authorities re- for federal tax purposes (see Rev. Ruls.
ment consistent with that of the partner- lated to partnership continuations and 84-52, 95-37, and 95-55). Going for-
ship (see Rev. Proc. 92-92). when they may apply. ward, A and B will file the return under
the new business name CD LLC, but
Keep these exclusions in mind When does a partnership there is no requirement that the part-
Various forms of debt workouts and continue? When does it nership obtain a new federal employer
restructurings can trigger COD income, terminate? identification number.
which results in taxable income to the A partnership continues when it does
debtor unless specifically excluded under not meet the definition of a termina- Rev. Rul. 66-264
Sec. 108. Two key Sec. 108 exclusions are tion under Sec. 708(a). A partner- Partnership continuations may occur
the bankruptcy and insolvency exclusions. ship terminates when no part of any in more complex transactions than in
These exclusions operate similarly but with businesses, financial operation, or Example 1.
important differences. If a taxpayer excludes venture of the partnership continues
cancellation of debt from income under to be carried on by any of its partners Example 2. “Drop down” continua-
the bankruptcy or insolvency exclusion, the in an entity taxed as a partnership tion of an operating partnership: A
taxpayer must account for that benefit by (Sec. 708(b)). Consider the follow- and B are members in OpCo LLC.
correspondingly reducing its tax attributes. ing example: The members are approached by
Other situations in which COD income Sponsor, a private-equity fund that
does not arise include where the liability Example 1. “Drop down” continua- is interested in acquiring a majority
discharged would have been deductible if tion: A and B are the sole members interest in OpCo. Sponsor forms
paid by the taxpayer and in the case of a of AB LLC, a limited liability com- NewCo LLC and funds it with cash.
purchase-money debt reduction. Tax advis- pany (LLC) taxed as a partnership. Immediately after the formation
ers should keep these tax considerations On April 30, 20X2, they transfer of NewCo, A and B contribute a
relating to COD income events top of 100% of their units in AB to a new percentage of their OpCo interests
mind during times of economic turmoil, legal entity — CD LLC — in to NewCo in exchange for units
when debt workouts and restructurings exchange for 100% of the units of totaling 10% of the value of NewCo.
often occur. CD. Immediately after the transac- After the contribution, NewCo
From Nick Gruidl, CPA, MBT (Nick. tion, A and B are members in CD, acquires the remaining partnership
Gruidl@rsmus.com), Washington, D.C.; which owns 100% of AB. interests of OpCo from the members
Joseph Wiener, J.D., LL.M. (Joseph. with cash. Following the transaction,
Wiener@rsmus.com), New York City; and Although it appears that AB be- NewCo is owned 90% by Sponsor
Sarah Lieberman, J.D. (Sarah.Lieberman@ comes a disregarded entity, the trade and 5% equally by A and B. OpCo
rsmus.com), Washington, D.C. or business of AB continues to be is owned 100% by NewCo.

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