safe harbor under which the Internal Revenue Service (IRS) will not challenge a determination by a publicly traded partnership (PTP) that income from discharge of indebtedness (COD income) is qualifying income

Rev. Proc.  2012-28

This revenue procedure provides a  under section 7704(d) of the Internal Revenue Code.


.01 Section 61(a) provides generally that gross income means all income from whatever source derived.  Section 61(a)(12) provides that gross income includes COD income. 

.02 Section 7704(a) provides generally that, except as provided in section 7704(c), a PTP is treated as a corporation. 

.03 Section 7704(b) provides that the term “publicly traded partnership” means any partnership if either (1) interests in such partnership are traded on an established securities market, or (2) interests in such partnership are readily tradable on a secondary market (or the substantial equivalent thereof).

.04 Section 7704(c)(1) provides that section 7704(a) shall not apply to any PTP for any taxable year if such partnership met the gross income requirements of section 7704(c)(2) for such taxable year and each preceding taxable year beginning after December 31, 1987, during which the partnership (or any predecessor) was in existence (qualifying income exception).  Section 7704(c)(2) provides that a partnership meets the gross income requirements of section 7704(c) for any taxable year if 90 percent or more of the gross income of such partnership for such taxable year consists of qualifying income.  Section 7704(c)(3) provides that section 7704(c) does not apply to any partnership that would be described in section 851(a) if such partnership were a domestic corporation.

.05 Section 7704(d)(1) provides in general that the term “qualifying income” means: (A) interest, (B) dividends, (C) real property rents, (D) gain from the sale or other disposition of real property (including property described in section 1221(a)(1)), (E) income and gains derived from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber), or industrial source carbon dioxide, or the transportation or storage of any fuel described in subsection (b), (c), (d), or (e) of section 6426, or any alcohol fuel defined in section 6426(b)(4)(A) or any biodiesel fuel as defined in section 40A(d)(1), (F) any gain from the sale or disposition of a capital asset (or property described in section 1231(b)) held for the production of income described in any of the foregoing subparagraphs, and (G) in the case of a partnership described in the second sentence of section 7704(c)(3), income and gains from commodities (not described in section 1221(a)(1)) or futures, forwards, and options with respect to commodities.  Section 7704(d)(4) provides that “qualifying income” also includes any income that would qualify under section 851(b)(2)(A) or section 856(c)(2).

 .06 The legislative history to section 7704 provides that the purpose of the section 7704(c) exception for PTPs with qualifying income is to except from entity level tax those partnerships that engage in activities that are commonly considered as essentially no more than investing or that have traditionally been conducted in partnership form.  See H.R. Rep. No. 391 (Part 2), 100th Cong., 1st Sess. 1066-69. 

.07 Section 1.163-8T of the temporary Income Tax Regulations prescribes rules for allocating interest expense for purposes of applying the passive loss limitation of section 469 and the nonbusiness interest limitations of section 163(d) and (h).  Under these rules, interest expense is generally allocated in the same manner as the debt to which the interest expense relates.  Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures. 
This revenue procedure applies to PTPs with COD income that use the qualifying income exception in section 7704(c) to avoid corporate treatment under section 7704(a). 

  The IRS will not challenge a PTP’s determination that COD income is qualifying income under section 7704(d) if COD income is attributable to debt incurred in direct connection with activities of the PTP that generate qualifying income (qualifying activities).  The PTP may demonstrate that COD income is attributable to debt incurred in direct connection with the PTP’s qualifying activities by any reasonable method.  One reasonable method for demonstrating that COD income is attributable to debt incurred in direct connection with the PTP’s qualifying activities is to trace the proceeds of the debt generating COD income to qualifying activities under an approach similar to the one used in section 1.163-8T.  Ordinarily, a method that allocates COD income based solely on the ratio of qualifying gross income to total gross income will not be considered reasonable.  The IRS may consider a request for a private letter ruling on whether a method is reasonable.  

This revenue procedure is effective for COD income of a PTP attributable to debt discharged on or after June 15, 2012.  PTPs may apply this revenue procedure for COD income attributable to debt discharged in any taxable year for which the statute of limitations has not expired.

The principal author of this revenue procedure is Wendy L. Kribell of the Office of Associate Chief Counsel (Passthroughs & Special Industries).  For further information regarding this revenue procedure contact Wendy L. Kribell on (202) 622-3050 (not a toll free call).