Donald Trump’s Billion Dollar Loss: Good Tax Planning, or Dubious Trick?

Donald Trump’s tax returns have led to intense interest in and speculation concerning his tax positions. Recently, the New York Times[1] reported that he had nearly a billion dollars of net operating loss on his 1995 tax returns, available for carryover for many years.

Tax commentators have speculated about the loss and the corresponding “cancellation of debt” (COD) income (discussed below) which would reverse the loss. Possibilities include the “qualified real property business indebtedness” exclusion from cancellation of debt income, a tax shelter technique[2] and an S corporation technique[3] that would have been unusual for a real property business (because such businesses were typically organized as partnerships).

Recently, the New York Times[4] claims to have discovered the method that Trump used to avoid COD income.

Background of the Matter

In the early 1990s, the Trump organization (“Trump”) incurred losses on its real estate ventures, such as the Taj Mahal. It borrowed heavily to finance the projects.

In order to refinance the debt, Trump demanded and apparently received modifications of the debt. Under normal tax rules, a dollar of cancelled debt is taxed just like any other dollar of income. Thus, Trump would have recognized income from the refinancing, which would have offset any losses it otherwise had. This result does create some economic hardship, as people receiving cancellation of debt income are often insolvent, but there are rules to ease this pain.[5]

However, under then existing law, if a corporation paid off its debt by exchanging equity (i.e., stock) for the debt, it would not recognize any COD income. By 1993, this technique had been banned specifically for corporations. However, it was not clear if a partnership could use the same technique. Trump took the position that partnership equity for debt would not result in COD income.

In most circumstances, when entities issued equity to pay off debts and avoid COD income, they paid off their own debts.  In this case, the debt being extinguished was debt of Trump’s related financing corporations (guaranteed by Trump’s partnerships), which existed because of New Jersey casino regulations. Trump took the position that the corporations’ debt was really the partnerships’ debt, as the corporations were mere agents or nominees of the partnerships. This is often a difficult position to sustain in tax law, which is biased towards treating legal entities as separate and holding taxpayers to the form they select for a transaction.

Trump’s position was supported by a tax opinion from the law firm of Willkie Farr & Gallagher.[6] Tax opinions are routinely requested by parties performing major transactions, particularly where there is tax uncertainty present because such opinions mitigate potential tax penalties if the IRS should disagree with the taxpayer’s reported position.

The confidence levels expressed by tax opinions translate to the following probabilities:

Confidence levelProbability of being upheld
More likely than notGreater than 50%
Substantial authority33%-40%
Reasonable basis20%-30%
Not frivolousSome amount lower than reasonable basis, but not clear how low
FrivolousExtremely unlikely, to the point special penalties are likely to apply for frivolousness


In the case of Trump’s transaction, Willkie identified 8 key areas of tax uncertainty. It offered a more likely than not opinion on one issue, and a substantial authority level of confidence for the remainder of the issues. This meant that Trump was highly unlikely to face tax penalties for his position even if he lost on the substantive issue against the IRS.

In 2004, Congress removed from the Internal Revenue Code the partnership equity for debt exception to COD income.[7] Under current law, if a creditor exchanges a partnership debt for an interest in the partnership, the partnership is treated as if the debt were satisfied for cash equal to the fair market value of the interest received by the creditor. As a result, the partnership will recognize income from the COD to the extent that the interest received by the creditor is less than the face value of the debt. Key of the Regulations is the definition of “fair market value” for purposes of applying section 108(e)(8) to the cancellation of partnership indebtedness in exchange for an interest (profits or capital) in the venture. The fair market value of a partnership interest is its liquidation value, meaning “the amount of cash that the creditor would receive with respect to the debt-for-equity interest if, immediately after the transfer, the partnership sold all of its assets (including goodwill, going concern value, and any other intangibles associated with the partnership’s operations) for cash equal to the fair market value of those assets and then liquidated.” In other words, liquidation value is the amount credited to the creditor’s capital account.[8]





[5] Insolvent or bankrupt taxpayers have an exception for reducing their cancellation of debt income, but it forces them to reduce their positive tax attributes, such as their net operating losses; Trump did not use this exception.


[7] The American Jobs Creation Act of 2004 amended §108(e)(8) to treat partnership in the same way as corporations regarding cancellation of indebtedness. American Jobs Creation Act of 2004, P.L. 108-357, §896(a), effective Oct. 22, 2004.

[8] Treas. Reg. §1.108-8(b)

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Roger Royse

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City.
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