Does the freeing of assets theory have vitality?
Pursuant to Sec. 61(a)(12), a taxpayer generally must include as gross income any income derived from discharge of indebtedness. This rule is of judicial origin. In the seminal case of Kirby Lumber Co., 284 US 1 (1931), the taxpayer corporation issued its own bonds at par. Later in the same year, it purchased some of those bonds on the open market for less than par. The Supreme Court held that the taxpayer had income of the difference. “As a result of its dealings it made available … assets previously offset by the obligation of bonds now extinct.” (Emphasis added.) Thus was born the freeing of assets theory as a rationale for justifying cancellation of debt (COD) income. The Board of Tax Appeals picked up on the freeing of assets theory in Fulton Gold Corp.
