Opinion
Docket No. 5946-66.
1969-04-23
LEON S. AND DOROTHY A. BLACK, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
David R. Frazer, for the petitioners. Edward B. Simpson, for the respondent.
David R. Frazer, for the petitioners. Edward B. Simpson, for the respondent.
The petitioners sold residential property, a part of the selling price of which was represented by a note secured by a second mortgage upon the property. Later the petitioners relinquished such note for cash and another note which together totaled less than the face amount of the original note. Held, that since the fair market value of the property securing the original note was in excess of the indebtedness secured by both the first and second mortgages, the indebtedness due the petitioners was not worthless in whole or in part, and the petitioners are not entitled to a bad debt deduction under sec. 166, I.R.C. 1954.
ATKINS, Judge:
The respondent determined a $2,211.21 deficiency in income tax against the petitioners for the taxable year 1963.
The only issue for our decision is whether petitioners are entitled to deduct as a bad debt the amount of $3,693.61, the difference between a $15,031.81 note they received from the purchaser of their home at the time of its sale in 1962 and $11,338.20 (cash of $5,031.81 and a note for $6,306.39) which they received in substitution for such note in 1963.
FINDINGS OF FACT
Some of the facts have been stipulated and are incorporated herein by this reference.
The petitioners, Leon S. and Dorothy A. Black, are husband and wife. At the time they filed their petition herein they resided in Phoenix, Ariz. Their returns for the taxable years 1962 and 1963 were filed with the district director of internal revenue, Phoenix, Ariz.
On June 18, 1962, the petitioners purchased, for $54,500, a residence located on the south side of Camelback Mountain overlooking the cities of Tempe and Phoenix, which will hereinafter be referred to as the Camelback property. They made a net cash payment of $21,762.61 and assumed an existing mortgage of $32,737.39.
At the time they purchased the Camelback property, the petitioners were living in a summer cottage in Pinetop, Ariz. They had transferred a home in Phoenix which they previously occupied to their son Richard and it was their intention to occupy the Camelback property as their personal residence. However, shortly after they purchased the Camelback property, Dorothy suffered a recurrence of a heart ailment as a result of which they decided not to use the Camelback property as their residence, but to sell it. Such decision was made at some time more than a month after the purchase. They did not move into the house, although they did stay there overnight a few times.
In November 1962, the petitioners sold the Camelback property to Raymond and Geraldine Roy (hereinafter referred to as the Roys) for $54,500, and conveyed legal title to them. At that time the fair market value of the property was not less than $54,500. The Roys paid petitioner $7,000 in cash, assumed the existing mortgage with an unpaid balance of $32,468.19, and gave the petitioners a $15,031.81 negotiable promissory note secured by a second mortgage upon the property.
Such second mortgage provided that if the mortgagor should fail to make any required payment, including taxes, when due the whole amount of the debt should become due and be collectible by foreclosure of the mortgage. It also provided that if the mortgagor should fail to pay taxes the mortgagee might pay them, in which case the amount thereof should be a part of the debt secured by the mortgage and a lien upon the premises. It further provided that in the event of foreclosure the mortgagor should pay the mortgagee, in addition to the costs of the foreclosure, a reasonable amount as attorney's fees and a reasonable fee for title search, which should be a lien on the premises and secured by the mortgage.
At no time while the petitioners owned the Camelback property did they rent it or offer for rent.
At about the same time that petitioners sold the Camelback property to the Roys, they loaned the Roys $30,000, evidenced by a negotiable promissory note in that amount and secured by a first mortgage on certain property owned by the Roys on North Seventh Street in Phoenix (hereinafter referred to as the North Seventh Street property). It was agreed that $7,000 of the $30,000 should be used to make the $7,000 downpayment on the Camelback property, and that the remainder should be used to improve both the Camelback property and the North Seventh Street property. Subsequently, the Roys did improve the Camelback property by landscaping the yard and installing air conditioning and extensive plumbing in the guest house attached thereto. They also used some of the $30,000 to clear title to the North Seventh Street property.
The second mortgage note given by the Roys to petitioners upon their purchase of the Camelback property required a first payment of $500, plus interest, on June 1, 1963. The Roys failed to make such payment. At that time the first mortgage was also in default. Also prior to June 1, 1963, the petitioners had had difficulty in obtaining payment of checks given by the Roys to them on the $30,000 first mortgage on the North Seventh Street property. Geraldine Roy told petitioners that she was unable to meet the payments under the first and second mortgages on the Camelback property. She told the petitioners that she was ill with cancer and that her husband was chronically ill in Chicago and unemployed and that she had sold the jewelry business which she had operated in Phoenix. She stated that she wished to refinance the first mortgage on the Camelback property to permit her to make smaller payments over a longer term but that in order to do so the holder of the first mortgage would require the removal of the petitioners' second mortgage on the property. She also requested a reduction of her $15,031.81 indebtedness to the petitioners.
The petitioners came to the conclusion that the Roys were unable to meet all the mortgage payments on the Camelback property. On July 24, 1963, they accepted, in substitution for the $14,031.81 promissory note and second mortgage on the Camelback property, cash in the amount of $5,031.81 and a promissory note of the Roys in the amount of $6,306.39 secured by a second mortgage on the North Seventh Street property. The petitioners had considered foreclosing on the Camelback property under their second mortgage, but decided against that course because they thought it would take about 2 years to foreclose and that they would incur expenses, including taxes and attorney fees, amounting to about $3,500 to $4,000.
At some subsequent date not shown by the record, the holder of the first mortgage on the Camelback property foreclosed under his mortgage. In April 1965, the petitioners began foreclosure proceedings under their mortgage on the Seventh Street property.
On July 24, 1963, the fair market value of the Camelback property was at least $54,500.
On their return for the taxable year 1963, petitioners deducted under the heading of ‘Interest’ an amount of $3,693.61, which was further described as ‘Discount for Cash Payment & Substitution of Better Security, etc., on 2nd Mortgage from Geraldine E. and Raymond L. Roy.’
In the notice of deficiency, the respondent disallowed the deduction with the explanation that ‘said amount does not constitute an allowable deduction under any provision of the Internal Revenue Code and represents a reduction in the selling price of your personal residence.’
OPINION
The petitioners contend that the $15,031.81 debt became worthless to the extent of $3,693.61 in 1963 and to that extent is deductible under section 166 of the Internal Revenue Code of 1954.
Such $3,693.61 represents the difference between the face amount of the $15,031.81 note surrendered by petitioners on July 24, 1963, and the amount accepted in substitution therefor, namely, $5,031.81 in cash and another note for $6,306.99.
Sec. 166 provides in part as follows:(a) GENERAL RULE.—(1) WHOLLY WORTHLESS DEBTS.— There shall be allowed as a deduction any debt which becomes worthless within the taxable year.(2) PARTIALLY WORTHLESS DEBTS.— When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.(d) NONBUSINESS DEBTS.—(1) GENERAL RULE.— In the case of a taxpayer other than a corporation—(A) subsections (a) and (c) shall not apply to any nonbusiness debt; and(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months.(2) NONBUSINESS DEBT DEFINED.— For purposes of paragraph (1), the term ‘nonbusiness debt’ means a debt other than—(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.
The respondent, on the other hand, contends that the petitioners have failed to establish that the $15,031.81 debt was worthless in whole or in part in 1963, and thus are not entitled to any deduction on account thereof.
Both parties seem to agree that the debt in question was a nonbusiness debt. In any event, we think it is clear that it was such. A nonbusiness debt is defined in section 166(d)(2) as any debt other than one created or acquired in connection with a trade or business of the taxpayer, or a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business. Here the debt arose out of the sale of the Camelback property which the petitioners had purchased with the intention of use as their personal residence. There has been no showing that the debt had any connection whatever with any trade or business of the taxpayers. Indeed, we are not informed as to what business the taxpayers were engaged in, if any.
Section 166(d)(1) provides that in the case of a taxpayer other than a corporation where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered as a loss from the sale or exchange of a capital asset held for not more than 6 months. Furthermore, to be so treated, such a debt must become entirely worthless within the taxable year. Section 1.166-5(a) of the Income Tax Regulations provides in part as follows:
If, in the case of a taxpayer other than a corporation, a nonbusiness debt becomes wholly worthless within the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. * * * A loss on a nonbusiness debt shall be treated as sustained only if and when the debt has become totally worthless, and no deduction shall be allowed for a nonbusiness debt which is recoverable in part during the taxable year.
Such regulation is in conformity with the purpose of the statute. See H. Rept. No. 2333, 77th Cong., 2d Sess., p. 76, explaining the congressional intent when, in the Revenue Act of 1942, provisions were first enacted distinguishing between business and nonbusiness debts.
See Rollins v. Commissioner (C.A. 4), 276 F.2d 368, affirming 32 T.C. 604.
Such committee report contains the following:‘A new provision is added providing for special treatment of nonbusiness debts, applicable in the case of a taxpayer other than a corporation. If such a debt becomes entirely worthless within the taxable year, the loss resulting therefrom is to be considered a loss from the sale or exchange of a capital asset held for not more than 15 months. The provisions of section 23(k)(1), as amended by this section, with respect to a debt which has become partially worthless, do not apply in the case of a nonbusiness debt; and a loss with respect to such a debt will be treated as sustained only if and when the debt has become totally worthless. * * * ’
Apparently the petitioners do not contend that the debt became worthless in whole but only to the extent of $3,693.61. We think it clear that such debt did not become worthless either in whole or in part. The fact that the petitioners, for reasons satisfactory to themselves, relinquished their claim against the debtor to the extent of $3,693.61 does not of itself establish that the debt was worthless to any extent. See Raffold Process Corp. v. Commissioner, (C.A. 1) 153 F.2d 168, affirming a Memorandum Opinion of this Court, and O'Bryan Bros. v. Commissioner, (C.A. 6) 127 F.2d 645, affirming 42 B.T.A. 18, certiorari denied 317 U.S. 647. See also sec. 1.166-2(a), Income Tax Regs.
The $15,031.81 note was secured by a second mortgage on the Camelback property. When, on July 24, 1963, the petitioners relinquished such note and accepted cash of $5,031.81 and a note for $6,306.39 in substitution therefor, the Camelback property had a value of at least $54,500. The amount of the first mortgage on such property was originally $32,468.19, and there is no evidence to show that it was any greater on July 24, 1963. Thus, it would appear that the value of property exceeded the first mortgage by at least $22,031.81, which was more than sufficient to cover the indebtedness secured by the second mortgage. The petitioners contend that had they foreclosed they would have had expenses, including property taxes and attorney fees, of some $3,500 to $4,000. Even if so, it would appear that the amount which would be realized upon a foreclosure of the property would be sufficient to meet such expenses and still allow for payment of the $15,031.81 indebtedness.
Sec. 1.166-2(a), Income Tax Regs., provides as follows:(a) General rule. In determining whether a debt is worthless in whole or in part the district director will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor.
In view of the foregoing, we hold that the petitioners have not established that the debt became worthless, and we accordingly approve the respondent's determination.
Decision will be entered for the respondent.