required to recognize income from discharge of indebtedness, gain deferred pursuant to its installment sale, or gain on a disposition of an installment obligation.

The taxpayer sold property to a new corporation controlled by a private equity firm in exchange for cash and installment notes. The notes were issued by two LLCs. A collateral note was purchased to finance the payments of interest and principal required by one of the installment notes. The collateral note was then pledged in exchange for a guaranty of payment of principal and interest to the installment note’s holder.

In this case, the taxpayer formed a wholly owned subsidiary, and that subsidiary in turn formed another wholly owned subsidiary that held the installment note and the guaranty. Both subsidiaries were disregarded entities for tax purposes. This transaction allowed the taxpayer to defer reporting the gain on the sale of the property until the installment note’s maturity or until another event triggered Internal Revenue Code section 453 gain recognition. As a result of a bankruptcy filing, a default event occurred on the installment note. The taxpayer asserted that it did not have to recognize gain on the income from the installment note until the bankruptcy becomes final and any payout to the taxpayer is transferred to the holders of the notes.

The IRS said that the installment note and guaranty have not been abandoned and have value as a result of the future bankruptcy payouts. As a result, the taxpayer is not required to recognize income from the discharge of indebtedness in the years at issue. The installment note has not become unenforceable, so the taxpayer is not yet required to recognize income on the note as an installment obligation. Also, the taxpayer had not effectively or actually disposed of the installment note at the time of the bankruptcy filing because the installment note had not become unenforceable, abandoned, or worthless.

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