rp-14-20.pdf

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Part III

Administrative, Procedural, and Miscellaneous

26 CFR 601.105: Examination of returns and claims for refund, credit or abatement;
determination of correct tax liability.

Rev. Proc. 2014-20

SECTION 1. PURPOSE

This revenue procedure provides a safe harbor under which the Internal Revenue
Service (the “Service”) will treat indebtedness that is secured by 100 percent of the
ownership interest in a disregarded entity holding real property as indebtedness that is
secured by real property for purposes of § 108(c)(3)(A) of the Internal Revenue Code.
SECTION 2. BACKGROUND
.01 Often borrowers incur debt in connection with real property used in a trade or
business. If the debt is later discharged, the income from the discharge of indebtedness
may be excluded from gross income if certain requirements are met. In some cases,
the real property is held by the borrower in an entity that is wholly owned by the
borrower, and is, for federal tax purposes, disregarded as an entity separate from its

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owner. In these cases, the debt may be secured by the borrower’s ownership interest in
the disregarded entity holding the real property.
.02 Section 61(a)(12) provides that gross income includes income from the
discharge of indebtedness.
.03 Section 108(a)(1)(D) excludes income from the discharge of indebtedness from
gross income if, in the case of a taxpayer other than a C corporation, the indebtedness
discharged is qualified real property business indebtedness (“QRPBI”).
.04 To qualify as QRPBI, § 108(c)(3) requires that the indebtedness must be
incurred or assumed by the taxpayer in connection with real property used in a trade or
business and be secured by such real property. The taxpayer must make an election to
treat the indebtedness as QRPBI. QRPBI does not include qualified farm indebtedness.
Section 108(c)(3)(B) provides that QRPBI must be indebtedness that was incurred or
assumed before January 1, 1993, or if the indebtedness was incurred or assumed on or
after January 1, 1993, it must be qualified acquisition indebtedness. Section 108(c)(3)
also provides that indebtedness under § 108(c)(3)(B) includes indebtedness resulting
from the refinancing of indebtedness under § 108(c)(3)(B), but only to the extent it does
not exceed the amount of indebtedness being refinanced.
.05 Section 108(c)(4) defines qualified acquisition indebtedness as indebtedness
incurred or assumed to acquire, construct, reconstruct, or substantially improve real
property used in a trade or business.

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.06 Section 108(c)(2)(A) limits the amount that may be excluded from gross income
with respect to a discharge of QRPBI to the excess of (i) the outstanding principal
amount of the QRPBI immediately before the discharge, over (ii) the fair market value of
the real property reduced by the outstanding principal amount of any other QRPBI
secured by the property at the time of discharge.
.07 Section 108(c)(1) provides that the basis of depreciable real property of a
taxpayer shall be reduced by the amount excluded from gross income under
§ 108(a)(1)(D).
.08 Neither the statute nor the legislative history contains any explanation of or
definition for the term “secured by such real property” used in § 108(c)(3)(A).
Mortgages are commonly used by lenders to secure an interest in real estate. The
legislative history does not suggest, however, that mortgages are the exclusive form of
security for § 108(c)(3)(A). See
H.R. Rep. No. 103-111 (1993), 1993-3 C.B. 167, 622-
625. The fact that the statutory language does not limit the § 108 security interest to a
mortgage indicates an intent to include a broader range of security interests.
.09 Section 301.7701-3(b)(1)(ii) of the Procedure and Administration Regulations
provides that certain entities (including limited liability companies) with a single member
that do not elect to be treated as corporations are disregarded as entities separate from
their owners for federal tax purposes (“disregarded entity”).
.10 In other contexts, the Service has, where certain conditions are satisfied, treated
debt as secured by real property when the debt is secured by the sole membership

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interest in a disregarded entity that holds the real property. See
Rev. Proc. 2003-65,
2003-2 C.B. 336.
SECTION 3. SCOPE
.01 This revenue procedure applies to the discharge of indebtedness of any
taxpayer, other than a C corporation, provided the requirements of section 3.03 of this
revenue procedure are satisfied.
.02 This revenue procedure provides a safe harbor under which the Service will
treat debt as “secured by” real property for purposes of § 108(c)(3)(A).
.03 The requirements of this section 3.03 of this revenue procedure are satisfied if:
(1) The taxpayer or a wholly owned disregarded entity of the taxpayer (“Borrower”)
incurs indebtedness.
(2) Borrower directly or indirectly owns 100% of the ownership interest in a separate
disregarded entity owning real property (“Property Owner”). Borrower is not the same
entity as Property Owner.
(3) Borrower pledges to the lender a first priority security interest in Borrower’s
ownership interest in Property Owner. Any further encumbrance on the pledged
ownership interest must be subordinate to the lender’s security interest in Property
Owner.
(4) At least 90 percent of the fair market value of the total assets (immediately
before the discharge) directly owned by Property Owner must be real property used in a

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trade or business and any other assets held by Property Owner must be incidental to
Property Owner’s acquisition, ownership, and operation of the real property.
(5) Upon default and foreclosure on the indebtedness, the lender will replace
Borrower as the sole member of Property Owner.
.04 If a taxpayer does not meet the requirements of this safe harbor, it is not
precluded from arguing, based on facts and circumstances, that its debt satisfies the
“secured by” requirement of § 108(c)(3)(A).
SECTION 4. PROCEDURE
Indebtedness that satisfies the requirements of section 3.03 of this revenue
procedure will be treated as indebtedness secured by real property for purposes of
§ 108(c)(3)(A). Provided the indebtedness meets the other requirements of § 108(c)(3),
such indebtedness will be QRPBI and, accordingly, any income from the discharge of
such indebtedness will be excluded from the taxpayer’s gross income pursuant to
§108(a)(1)(D) subject to the limitations provided in § 108(c). Further, as provided in §
108(c)(1), the basis of depreciable real property of the taxpayer will be reduced by the
amount excluded from gross income.
SECTION 5. EFFECTIVE DATE
This revenue procedure is effective for taxpayers who make an election under
§ 108(c)(3) regarding discharged indebtedness on or after February 5, 2014.

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DRAFTING INFORMATION
The principal author of this revenue procedure is Seoyeon Sharon Park of the Office
of Associate Chief Counsel (Income Tax and Accounting). For further information
regarding this revenue procedure, contact Ms. Park at (202) 317-7006 (not a toll-free
call).