When an LLC (taxed as a partnership) has multiple assets, common structuring is to consider separating the assets into wholly owned LLC subsidiaries, so that the assets of one subsidiary LLC are not subject to the liabilities of a different subsidiary LLC. A simple example would be an operating business where premises are going to be acquired. Common planning would be to structure ownership with Holdco LLC owning two single-member LLCs, one containing the operating business (“Operating LLC”) and the other owning the premises (“Real Estate LLC”). The premises would be acquired with nonrecourse debt secured by all the assets of Real Estate LLC, but there would be no guarantee of the debt by either Holdco LLC or Operating LLC. The premises would be rented to the operating business; however, for federal income tax purposes there would be no rental income and no rent expense (because one cannot rent property to oneself, which would be the case under this structure).

In the last decade, the IRS has issued two complicated private letter rulings, PLR 201644018 and PLR 202050014, in which the essence of the transaction was that the assets and liabilities of an underwater wholly owned LLC (the counterpart to Real Estate LLC) were contributed to a corporation as part of a bankruptcy restructuring. The IRS ruled that the debt was nonrecourse, consequently the amount of the debt was included in the amount realized, rather than producing COD income. However, because the transaction qualified as a §368(a)(1)(G) reorganization, §361, which provides for nonrecognition of gain in a reorganization transaction, was applicable. Moreover, as a sale or exchange transaction, rather than a COD transaction, there was no attribute reduction that accompanied the excluded gain. As reported in the October 23, 2026, issue of Tax Notes Federal, an IRS representative was quoted as indicating at an October 22^nd Practising Law Institute conference, that the IRS is rethinking this guidance “amid worries that taxpayers are using the guidance in those rulings to avoid cancellation of debt (COD) income.”

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