United States

Debt modifications during the COVID-19 crisis

Unexpected income could arise when modifying debt over $100 million


As businesses try to survive the COVID-19 pandemic and restart in its aftermath, modifications to existing debt agreements are all but certain. For businesses with debt that meets the definition of traded on an established market, debt modifications in a distressed market may result in unexpected cancellation of debt income. With the establishment of a five-year net operating loss carryback for years beginning in 2018-2020,1 unexpected income could reduce carryback refund opportunities.

Many changes to debt agreements are ‘modifications’ as defined in Treasury regulations.2 Examples include:

  • Deferral of payments of interest and extension of maturity date
  • Interest holidays
  • Changes in interest rates
  • Subordination of debt
  • Reduced collateral on debt
  • Change from recourse to nonrecourse

If a modification is ‘significant,’ as defined in Treasury regulations,3 the debt issuer may realize cancellation of debt (COD) income. Where the business has over $100 million in outstanding debt, the likelihood of a COD income event increases because of special rules for debt considered traded on an established market (Publicly Traded). As discussed below, the definition of ‘Publicly Traded’ for this purpose is broader than taxpayers may realize. Therefore, it is important that taxpayers analyze modifications made to debt and determine whether such debt is Publicly Traded. 

Debt modifications and debt-for-debt exchanges

If a transaction results in a significant modification to a debt instrument, the transaction is treated for federal income tax purposes as an exchange of the original debt instrument (the Old Debt) for a modified debt instrument (the New Debt).4 For this purpose, it does not matter whether an actual exchange of instruments occurs or not.5

The issue price of the New Debt is generally determined with reference to its fair market value (FMV) if a substantial amount of the New Debt is not issued for money, and either the New Debt or the Old Debt is Publicly Traded.6 Otherwise, the New Debt’s issue price is equal to its principal amount, provided it bears adequate stated interest.7 Therefore, where a modified debt is Publicly Traded and the modification does not include the issuance of a substantial amount of cash, the issue price is its FMV,8 which, as further discussed below, generally equals the sales or quoted price.  

Publicly Traded debt 

Tax rules define ‘Publicly Traded’ debt broadly. A debt instrument is Publicly Traded where a substantial amount of the debt is traded on an established market.9 Debt is traded on an established market if, at any time during the 31-day period ending 15 days after the issue date, there is for the debt instrument (i) a sales price, (ii) one or more firm quotes or (iii) one or more indicative quotes.10

A sales price exists if, within the 31-day period described above, the price for an executed purchase or sale of the debt instrument is reasonably available within a reasonable period of time after the sale.11 The sales price is reasonably available if such price, or information sufficient to calculate the price, is in a medium available to issuers of debt instruments, persons that regularly purchase or sell debt instruments, or brokers of debt instruments.12 A firm quote exists if a price quote is available from at least one broker, dealer or pricing service, and the quoted price is substantially the same as the price for which the person receiving the quoted price could purchase or sell the property.13 An indicative quote is when the price quote is not a firm quote as described above, but is a price quote available from at least one broker, dealer or pricing service.14

Price quotes may be obtained through subscription debt pricing services (e.g., IHS Markit or Refinitiv LPC). As such, debt instruments with price quotes listed on these types of services during the 31-day period described above will be considered as debt traded on an established market. 

The presumption is that the sales price or quoted price as described above is equal to the FMV of the debt instrument.15 Additionally, there is an exception for small debt issues. If the outstanding stated principal amount of the debt instrument does not exceed $100 million, then the debt instrument is not treated as Publicly Traded.16

Income tax consequences of a debt-for-debt exchange involving publicly traded debt 

As discussed above, if the Old Debt is significantly modified and either the New Debt or the Old Debt is Publicly Traded, the issue price of the New Debt will be based on its FMV. If, as a result, the issue price on the New Debt is less than the adjusted issue price of the Old Debt, the debtor will realize COD income.17 The holder of the debt generally recognizes loss on such an exchange.18


The COVID-19 pandemic has created an economic crisis that will drive many businesses to modify the terms of their debt. If the debt is Publicly Traded, a term broader than many realize, the likelihood of a debt modification resulting in COD income increases. Taxpayers should consult with their tax advisors regarding debt modifications and refinancing. 



1The Coronavirus Aid, Relief, and Economic Security Act amends section 172(b) to allow for the carryback of losses arising in a taxable year beginning after Dec. 31, 2017 and before Jan. 1, 2021 to the prior five taxable years.

2Reg. section 1.1001-3(c).

3Reg. section 1.1001-3(b).

4Reg. section 1.1001-3(b). A modification is significant “only if, based on all facts and circumstances, the legal rights or obligations that are altered and the degree to which they are altered are economically significant.” Reg. section 1.1001-3(e). Specific types of significant modifications listed in Reg. section 1.1001-3(e) include, among others, certain changes in (i) yield, (ii) timing of payments, (iii) obligor or security, or (iv) payment expectations.  

5Rev. Rul. 81-169, 1981-1 C.B. 429; Rev. Rul. 73-160, 1973-1 C.B. 365. 

6Reg. sections 1.1273-2(b) and (c). If a substantial amount of the New Debt is issued for money, then the issue price is “the first price at which a substantial amount of the debt instrument is sold for money” (i.e., the amount paid for the debt instrument). Reg. section 1.1273-2(a).  

7Section 1274. 

8Reg. section 1.1273-2(b) and (c).

9Reg. section 1.1273-2(b)(1).

10Reg. section 1.1273-2(f)(1).  

11Reg. section 1.1273-2(f)(2). 

12Id. Some debt sales prices are publicly available, but it is important to bear in mind that a debt can meet the ‘Publicly Traded’ definition even if no sales prices are publicly available.  

13Reg. section 1.1273-2(f)(3). 

14Reg. section 1.1273-2(f)(4).

15Reg. section 1.1273-2(f)(5). 

16Reg. section 1.1273-2(f)(6). 

17Section 108(e)(10); Reg. section 1.61-12(c)(2)(ii). 

18Section 165. Exceptions to loss recognition may apply. For example, loss generally is not recognized by the holder of the debt if the debt-for-debt exchange occurs in a corporate recapitalization qualifying under section 368(a)(1)(E).



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