The Option Aspect of Non-Recourse Debt

In the article, Willis replies to a letter from Robert Feldgarden, Philip A. McCarty, and Neil D. Kimmelfield (Tax Notes, June 17, 1991, p. 1462) and a special report by Yishai Beer (Tax Notes, November 18, 1991, p. 837).These earlier works argued that a nonrecourse loan should be seen as a combination of a loan and an option by the borrower to put the property to the lender at the face of the nonrecourse debt. They argued that the loan portion of the transaction should be taxed as a loan and that the option portion should be taxed as options are taxed. Beer explained that the option portion of the transaction would frequently be characterized as capital gain or loss.In this report, Willis agrees that nonrecourse loans may usefully be bifurcated, but he thinks that the question of whether the gain or loss is capital in nature is not so easy. He believes that the question over the proper characterization of the gain or loss as presented by Beer is spurious because characterization of gain or loss in this way is arbitrary at best. Willis would, instead, apply the tax benefit rule as a characterization rule. Without the tax benefit rule, there is no logical way to differentiate between capital gains or losses and ordinary income. He argues that the primary concern should be the matching of expenses against the associated income. This matching may require the capitalization of some expenses, but that does not alone tell us what the character of the gain or loss should be