This column continues the discussion1 of a modification of a defaulted loan secured by real property (referred to in this article as a troubled loan), reviewing the specific tests contained in the regulations2 on whether a modification is “significant,” thereby resulting in a taxable exchange. A taxpayer can rely on the specific tests to determine whether a modification is or is not “significant.” Except as otherwise provided under the tests, a modification is significant under the General Rule only if, based on all the facts and circumstances, the legal rights or obligations that are altered and the degree to which they are altered are economically significant.
Specific Tests
(1) Changes in Yield. A significant modification occurs if there is a change in the yield of a debt instrument by more than the greater of one-fourth of 1 percent, or 5 percent of the annual yield on an unmodified instrument. This test applies only to debt instruments with fixed payments, certain debt instruments with alternative payment schedules, certain debt instruments with a fixed yield, and variable rate debt instruments. A General Rule applies only when a specific test does not apply. Whether the change in the yield of any other debt instrument, such as a debt instrument that provides for contingent payments, is significant is determined under the General Rule.
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