Federal Income Tax Update
By 1. Taxpayer Denied a Bad Debt Deduction even though the Borrower had Cancellation of Debt Income; Kelly v. Commissioner, 139 F.4th 854 (9th Cir. 2025).
Between 2007 and 2010, Mr. Kelly loaned millions of dollars to his business entities. In December 2010, Mr. Kelly cancelled a portion of the debts his S corporations owed him. For 2010, Mr. Kelly reported $145 million in cancellation of debt (COD) income passing through his S corporations but excluded that entire amount from taxable income under the Section 108(a)(1)(B) insolvency exception. Mr. Kelly also claimed he was entitled to a nonbusiness bad debt deduction of nearly $87 million since the discharged debt write-off created COD income to his S corporations.
The IRS disallowed the bad debt deduction, arguing Mr. Kelly failed to establish the debts were completely worthless at the end of 2010, regardless of whether Mr. Kelly canceled the S corporations’ debts. Mr. Kelly contended, because the S corporations recognized cancellation of debt income under Section 61(a)(11), he must be entitled to a reciprocal worthless debt deduction under Section 166.
The Ninth Circuit Court of Appeals upheld the decision of the Tax Court that a bad debt deduction arises only where a debt becomes wholly worthless during the tax year. There is no presumption of such worthlessness merely because the borrower recognized COD income from the discharge of that same debt. Under Section 166, a nonbusiness bad debt deduction arises only where the taxpayer establishes: (1) a bona fide debt; (2) adjusted tax basis in the debt sufficient to claim the deduction; and (3) the debt became wholly worthless during the tax year. Reg. 1.166-5(a)(2). The court stated the terms worthless and discharge do not have the same meaning. Worthless means lacking value, whereas discharge means a release from a repayment obligation. Therefore, debt discharge does not, as a matter of law, eliminate the debt’s prior objective value and render it worthless. Moreover, the taxpayer must prove the debt is totally worthless. Mr. Kelly conceded the debts were not totally worthless because his S corporations still held some assets at the end of 2010.
2. Eleventh Circuit Confirms Glade Creek’s Conservation Easement Charitable Contribution Deduction Limited to Adjusted Tax Basis in Inventory; Glade Creek Partners, LLC, et al. v. Commissioner, No. 23-14039 (11th Cir. 2025).
In Glade Creek, the Eleventh Circuit Court of Appeals upheld the Tax Court decision that Glade Creek’s charitable conservation easement deduction is limited to its adjusted tax basis in inventory real property subject to the conservation easement.
The history of the Glade Creek conservation easement began in 2006 when International Land Consultants Inc. (“ILC”) purchased nearly 2,000 acres of undeveloped land in Tennessee. ILC planned to develop the property and market it as a residential vacation community. Because of the 2008 economic recession, ILC’s plans for the property soured. One of its investors abandoned the project, and ILC’s lender began pressuring ILC to liquidate its holdings to reduce infrastructure loans. As a result of pressure from its lender, ILC’s remaining two members and another party (affiliated with ILC) formed Hawks Bluff Investment Group, Inc. Hawks Bluff assumed ILC’s debts in exchange for some of ILC’s land.
Over the next several years, conditions did not improve for Hawks Bluff. It ultimately decided to engage in a syndicated conservation easement to raise funds to pay its debts. As part of its conservation easement plan, Hawks Bluff formed Glade Creek, LLC and capitalized Glade Creek, LLC with 1,300 acres of land formerly owned by ILC. After selling equity units to investors, in 2012, Glade Creek granted a conservation easement on the property to a local land conservancy. Glade Creek claimed a substantial charitable contribution deduction on its 2012 tax return based on the appraised value of the easement property.
The Eleventh Circuit ruled Glade Creek’s charitable contribution deduction for the easement was limited to Glade Creek’s tax basis in the easement property under Sections 170(e) and 724(b). Section 170(e) provides a taxpayer must reduce any charitable contribution deduction by the ordinary income or short-term capital gain that would result from a hypothetical sale of the donated property. Under Section 724, any gain related to property contributed to a partnership by one of its partners is treated as ordinary income if the contributing partner held the property as inventory during the previous five years.
On its 2012 tax return, Hawks Bluff stated it was a real estate dealer and reported the easement property as inventory. Hawks Bluff also reported a decrease in inventory to account for the transfer of the easement property to Glade Creek. The court held the easement property contributed to Glade Creek had been inventory in the hands of its contributing partner, Hawks Bluff. Because Glade Creek would have recognized ordinary income had Glade Creek sold the property in December 2012, Glade Creek’s charitable deduction was limited to its adjusted tax basis in the easement property.
III. Second Circuit Rules 90-Day Period for Challenging Tax Deficiency is Procedural rather than Jurisdictional; Buller v. Commissioner, 152 F.4th 84 (2nd Cir. 2025).
In Buller, the Second Circuit joined the Third and Sixth Circuits in ruling the 90-day statutory time limit for filing a Tax Court petition to challenge a notice of deficiency is procedural and not jurisdictional. Previously, the Fourth Circuit in Sanders v. Commissioner, 161 TC No. 8 (2023), held the 90-day period for challenging a notice of deficiency is jurisdictional.
IV. Charitable Contribution Deduction Denied where it was Claimed by the Wrong Taxpayer; Corning Place Ohio, LLC vs. Commissioner, 158 F. 4th 715, (6th Cir. 2025).
On May 25, 2016, Corning Place Ohio, LLC donated a historic preservation and conservation easement on the Garfield Building, which was an eleven-floor 19th-century building in Cleveland. An easement granted the charity the right to modify the Garfield Building’s facade and increase its height by 34 stories. Corning Place claimed a charitable contribution deduction for the easement on its 2016 partnership tax return. However, from May 15, 2016, to July 7, 2016, Corning Place was a single-member LLC.
Prior to May 16, 2016, Corning Place was a multi-member LLC. By May 18, 2016, all but one of Corning Place’s members had surrendered their membership interests, which left Corning Place as a single-member LLC as of May 18, 2016. Therefore, for approximately seven weeks between May 18 and July 6, Corning Place was a sole proprietorship and not a partnership. Corning Place did not become a partnership again until a new investor was admitted around July 7, 2016.
The Court of Appeals denied the charitable deduction on the simple basis that it was claimed by the wrong taxpayer. Corning Place was not a separate taxpayer when it granted the conservation easement.
Keith Wood is an attorney with Carruthers & Roth, P.A. in Greensboro.