Discharge of mortgage indebtedness on personal residence

The Internal Revenue Service has ruled that a financially solvent taxpayer realizes income when he or she prepays the mortgage on a personal residence at less than the outstanding principal balance (Rev. Rul. 82-202, 1982-48 I.R.B. 5).

The ruling concerned a financial institution which offered a 10percent discount to individuals who would prepay existing lowinterest mortgages on their personal residences. The taxpayer had borrowed from the financial institution in order to purchase a residence from a third-party seller. The fair market value of the residence was greater than the principal balance at the time of the transaction, and the taxpayer was not personally liable on the mortgage.

1

The ruling states that the taxpayer realized ordinary income to the extent of the 10-percent prepayment discount. The facts of the ruling did not involve bankruptcy, insolvency, or a qualified business indebtedness. Thus, the reduction of the taxpayer's liability produced taxable income under section 61(a)(12) and the Kirby Lumber rule. The ruling further added that the taxpayer would also realize ordinary income if (1) a discount was received for prepayment of only a portion of the outstanding balance of the mortgage, or (2) the taxpayer was personally liable on the mortgage.2 Explanation of the Bill

In general

The bill would provide for the exclusion of amounts otherwise includible in gross income by reason of the discharge (in whole or in part) of qualified mortgage indebtedness of the taxpayer. Qualified mortgage indebtedness would mean indebtedness incurred by an individual in acquiring the individual's principal residence, or in making improvements to the principal residence (if the costs of the improvements are taken into account in determining the taxpayer's basis). The amount excluded from income could not exceed the taxpayer's adjusted basis in the residence as of the close of the taxable year.

Under the bill, the taxpayer's basis in his or her principal residence would be reduced (but not below zero) by the amount of discharged indebtedness which was excluded from income under the new provision. If the taxpayer subsequently disposed of the principal residence in a taxable sale or exchange, any gain recognized would be recaptured as ordinary income to the extent of the excluded amount.

The term principal residence would have the same meaning as under section 1034 (relating to rollover of gain on sale of a principal residence). Under the section 1034 regulations, the determina

1 Under sec. 108(e)(5), the reduction of debt of a financially solvent purchaser of property, if the debt arose out of the purchase of the property, is to be treated as a nontaxable purchase price adjustment, rather than as a discharge of indebtedness. However, this exception applies only to debt owed to the seller of the property. The exception is thus inapplicable to most mortgage loans.

2 Rev. Rul. 82-202 concerned the amount of principal discount received by the taxpayer. Since interest payments are deductible, the forgiveness of mortgage interest payments generally does not result in gross income to a cash-basis taxpayer (sec. 108(e)(2)). However, the forgiveness of previously accrued and deducted interest results in realization of gross income.

tion of whether property constitutes the taxpayer's principal residence would be made on a facts and circumstances basis. Property used as a principal residence could include a houseboat, trailer, or stock in a cooperative housing corporation. However, the term principal residence would not include personal property (such as furniture) which is not treated under property law as a fixture (Treas. Reg. sec. 1034-1(c)(3)(i)).

Effective date

The bill would apply retroactively to taxable years beginning after December 31, 1953. Claims for retroactive credit or refund of overpayments arising by reason of the bill could be filed within the one-year period beginning on the date of enactment.

4. S. 1194-Senators Danforth, Symms, Chafee, Burdick, Pell, Wilson, Inouye, and Cohen

"Technology Education Assistance and Development Act of 1983"

and

5. S. 1195-Senators Bentsen and Chafee

"High Technology Research and Educational Development Act of 1983"

a. Increased Deduction for Transfers of Scientific, Technical, or Computer Equipment for Certain Research or Educational Purposes

Present Law

General reduction rule for donations of property

In general, the amount of charitable deduction otherwise allowable for donated property must be reduced by the amount of any ordinary gain which the taxpayer would have realized had the property been sold for its fair market value at the date of the contribution (Code sec. 170(e)).

Thus, a donor of inventory or other ordinary-income property (property the sale of which would not give rise to long-term capital gain) generally may deduct only the donor's basis in the property, rather than its full fair market value. In the case of property used in the taxpayer's trade or business (sec. 1231 property), the charitable dedution must be reduced by the amount of depreciation recapture which would be recognized on sale of the donated property. Special rule for certain research equipment donations

Under a special rule, corporations are allowed an augmented charitable deduction for donations of newly manufactured scientific equipment or apparatus to a college or university for research use in the physical or biological sciences (sec. 170(e)(4), added by the Economic Recovery Tax Act of 1981).1 This provision applies to charitable contributions made after August 13, 1981.

This increased deduction is generally for the sum of (1) the corporation's basis in the donated property and (2) one-half of the unrealized appreciation (i.e., one-half of the difference between the property's fair market value determined at the time of the contribution and the donor's basis in the property). However, in no event is the

1 Under a special rule enacted in 1976, an augmented charitable deduction also is allowed for corporate contributions of certain types of ordinary income property donated for the care of the needy, the ill, or infants (sec. 170(e)(3)).

deduction under the special rule allowed for an amount which exceeds twice the basis of the property.

To qualify for this special deduction rule, a corporate contribution of scientific equipment to a college or university must satisfy the following requirements:

(1) The property contributed was constructed by the corporate donor;2

(2) The contribution is made within two years of substantial completion of construction of the property;

(3) The original use of the property is by the college or university;

(4) Substantially all (at least 80 percent) of the use of the scientific equipment or apparatus by the college or university is for research (within the meaning of sec. 174), or for research training, in the United States in the physical or biological sciences;3

(5) The property is not transferred by the donee in exchange for money, other property, or services; and

(6) The taxpayer receives the donee's written statement representing that the use and disposition of the property contributed will be in accordance with the last two requirements.

Prior Committee Action

In the 97th Congress, the Committee on Finance reported, with amendments, a bill (H.R. 5573) which would have provided a special deduction rule for certain corporate charitable contributions of newly manufactured computer equipment to an elementary or secondary school for use at the school, or to a museum or library for use at the museum or library, directly in the education of elementary or secondary schoolchildren (S. Rep. No. 97-647). No further action was taken on that bill prior to adjournment of the 97th Congress.

Requirements for favorable treatment

The special deduction rule of H.R. 5573 would have applied to a charitable contribution by a corporation of computer equipment which satisfied all of the following requirements.

1. Qualifying computer equipment

The donated property must be tangible personal property which is inventory and must be computer equipment as defined in H.R. 5573. Also, the donated computer equipment must be assembled by the taxpayer, and the taxpayer must be regularly engaged in the business of assembling and selling equipment of the same kind as the donated property.

H.R. 5573 defined computer equipment qualifying for the special deduction rule to mean only

(a) a data processor which could be programmed in at least three standard computer languages, which has a random access memory

2 Property is to be treated as constructed by the taxpayer only if the cost of parts (other than parts manufactured by the taxpayer or a related person) used in construction does not exceed 50 percent of the taxpayer's basis in the property.

3 For purposes of this limitation on research use, and on research training use, the physical sciences include physics, chemistry, astronomy, mathematics, and engineering, and the biological sciences include biology and medicine.

with a capacity for at least 32,000 bytes, and which is (or could be) connected with a screen for visual display of the data;

(b) a display screen, a printer, or a disc drive, but only if donated by the taxpayer together with the donated data processor; and (c) related installation equipment.

2. Eligible donees

The computer equipment must be donated to a qualified oranization (located in the United States), defined by H.R. 5573 to mean(a) an educational organization (within the meaning of sec. 170(b)(1)(A)(ii);a

(b) an elementary or secondary school operated as an activity of a tax-exempt section 501(c)(3) organization (such as a church), provided that such school normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on; or

(c) a tax-exempt museum or library which is described in section. 501(c)(3), which is operated by a governmental unit, or which is operated as an activity of a section 501(c)(3) organization.

3. Governing body

The contribution of computer equiptment to an eligible donee must be made through the donee's governing body.

4. Time of contribution

The contribution must be made within six months after substantial completion of construction of the computer equipment. For any one donor corporation, only contributions made during a single taxable year of the corporation beginning in 1983, in 1984, or in 1985 would be eligible for the special rule in H.R. 5573.

5. Limitation to new equipment

The original use of the donated computer equipment must be by the donee.

6. Schoolchild education use requirement

Substantially all (at least 80 percent) of the use of the donated computer equipment by the donee must be at the location of the donee and must be directly in the education of elementary and secondary schoolchildren.

7. Prohibition on donee sale

The donated computer equipment may not be transferred by the donee in exchange for money, other property, or services.

* An educational organization is described in sec. 170(b)(1)(A)(ii) “if its primary function is the presentation of formal instruction and it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. The term includes institutions such as primary, secondary, preparatory, or high schools, and colleges and universities", and includes both public and private schools (Reg. sec. 1.170A-9(b)(1)).