Can private equity firms unwittingly trigger a tax when they invest in distressed assets?

A: All taxpayers, including private equity firms, can trigger a tax when investing in distressed assets. This can occur when a taxpayer acquires distressed debt and also owns some equity in the debtor, or is considered a related party of the debtor under tax law rules, even if these relationships do not exist on the date the distressed debt is acquired. A tax can be triggered in other situations, such as when the debt acquired is subsequently restructured which under tax law rules can be considered a constructive sale of the acquired debt instrument. There are several other collateral tax consequences to a borrower as well when a private equity firm acquires distressed assets that may trigger adverse tax consequences by triggering limitations on the borrower’s use of its own favorable tax assets, for example, NOL’s.