Debt Relief Option
My client borrowed money from a customer, used the proceeds
to prepay 5 years rent on a 5 year lease and to purchase
equipment.
Terms of debt instrument contained option for my client to
turn over remaining term on 5 year lease to the customer,
and to also turn over equipment purchased with the loan
proceeds, in exchange for cancellation of the debt.
After a couple of years, my client's basis in the prepaid
lease is 160,000, while basis in the equipment is 140,000
(cost of 280,000, less 140,000 in depreciation, including
approx 40,000 sec 179 expensing).
At same time, 440,000 is balance on the debt to the
customer.
My client has notified customer that they are exercising the
option, and stopped making payments on the debt, as well as
the lease, in November 2001. This is not bankruptcy
related, client simply wishes to continue doing business on
a smaller scale.
Debt instrument is silent on notice (time required) required
to exercise option, and client has taken position option has
been exercised. Have been communications between customer
and my client over this, but my client's attorney told my
client he has properly exercised his option.
Does this mean income of 140,000 (440,000 debt less 300,000
basis in prepaid lease and equipment) in 2001 for my
client? What if client's customer takes this to court?
Would court opinion in, say year 2002 ratifying my client's
position still mean the cancellation occurred in 2001?
I presume it would be helpful to deliver or turn over at
least on paper the balance of the lease and the title to the
equipment before 12/31/01 to lock in 2001 for the
transaction?? Notice per se may not be enough--so lock in
the date??? Ask counsel.
I am not so sure that settlement of a debt at some figure
constitutes income to your client. You may want to research
that point further. There is no forgiveness -- he merely
exercised one of the alternate payment options.