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Abstract
The frequency of partnership transactions involving disappearing debt has been increasing. Certainly, the massive volume of debt restructurings during the recent economic downturn is partially responsible for the increase. Another contributing factor is the proliferation of disregarded entities, since their use can cause debt to disappear for tax purposes while remaining outstanding as a legal matter. A close look at the five primary cases of disappearing debt in partnership transactions reveals that these cases are not unsolvable. In fact, the mystery of these transactions can be unlocked using the following set of keys. The form of a transaction should generally be respected and should govern the tax consequences of the transaction. In analyzing every case of disappearing debt, three potential tax consequences must be considered - the Debtor's Gain/Loss, the Debtor's COD/Deduction, and the Creditor's Gain/Loss. In the context of a nonrecognition transaction, the Debtor's Gain/Loss should not be recognized except to the extent gain is required to be recognized under Code Sec. 731 (a)(1 ). Otherwise, Code Sec. 752(b) (or the mechanic of Reg. §1.731-1 (c)(2) or Rev. Rul. 93-7) ensures that the Debtor's Gain/Loss is preserved. The Mark-to-Market Approach and the AIP Approach are two approaches for determining the Debtor's COD/Deduction.