Tufts v. C. I. R., 79-2258

• Decision Date: 27 July 1981
• Docket Number: No. 79-2258,79-2258
• Citation: 651 F.2d 1058
• Parties: 81-2 USTC P 9574 John F. TUFTS and Mary A. Tufts v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. . Unit A
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1058

651 F.2d 1058

81-2 USTC P 9574

John F. TUFTS and Mary A. Tufts v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 79-2258.

United States Court of Appeals, Fifth Circuit.

Unit A

July 27, 1981.

Rehearing and Rehearing En Banc Denied Oct. 19, 1981.

Ronald M. Mankoff, Dallas, Tex., for petitioners-appellants.

M. Carr Ferguson, Asst. Atty. Gen., Michael L. Paup, Atty., Gilbert E. Andrews Act. Chief, Appellate Section, Gilbert Rothenberg, Appellate Section, Tax Div., U. S. Dept. of Justice, Lester Stein, Chief Counsel, Internal Revenue Service, Washington, D. C., for respondent-appellee.

Appeal from the United States Tax Court.

Before BROWN, THORNBERRY and WILLIAMS, Circuit Judges.

THORNBERRY, Circuit Judge:

In August 1970, John Tufts and the remaining appellants formed a general partnership for the purpose of constructing an apartment complex in Duncanville, Texas. The partnership arranged for a loan of approximately.$1.8 million in order to finance construction of the complex. The mortgage note covered the entire cost and provided that neither the partnership nor the partners were personally liable for its repayment. The complex was completed in August 1971. Due to adverse economic conditions in the Duncanville area, the income generated by the complex was never enough to enable the partnership to make payments on the mortgage principal. As of August 28, 1972, the fair market value of the property had declined to.$1.4 million, and the principal balance due on the mortgage note remained at.$1.8 million. On that date, each partner sold his partnership interest and all of his right, title, and interest in property owned by the partnership to Fred Bayles, an unrelated third party. ¹ Mr. Bayles agreed to pay the expenses incurred by the partners as a result of the sale, up to $250. He paid no other consideration, and acquired the complex subject to the nonrecourse liability.

Each partner had included his proportionate share of the entire.$1.8 million in computing his basis in the partnership, and the Commissioner did not dispute the propriety of that computation. The Commissioner, however, included the full amount of the partnership nonrecourse liability in the amount realized upon the sale and therefore determined that each of the partners had realized a gain on the sale of his partnership interest. ² The partners appealed to the tax court, arguing that nonrecourse liabilities should be included in amount realized only to the extent of the fair market value of the partnership property securing the indebtedness. The tax court upheld the Commissioner, and the taxpayers filed this appeal.

The Supreme Court held in Crane v. Commissioner, 331 U.S. 1, 67 S.Ct. 1047, 91 L.Ed. 1301 (1947), that when property subject to a mortgage on which the owner of the property assumes no personal liability is sold, the amount realized includes the amount of the unassumed mortgage. ³ In footnote 37 of the Crane opinion, however, the Court observed:

Obviously, if the value of the property is less than the amount of the mortgage, a mortgagor who is not personally liable cannot realize a benefit equal to the mortgage. Consequently, a different problem might be encountered where a mortgagor abandoned the property or transferred it subject to the mortgage without receiving boot. That is not this case.

331 U.S. at 14 n.37, 67 S.Ct. at 1054. The question presented by this appeal is whether footnote 37 creates an exception to the Crane holding through its clear implication that the amount realized on the disposition of property encumbered by a nonrecourse mortgage cannot exceed the fair market value of the property. Our analysis of the reasons underlying the Crane decision leads us to the conclusion that such a fair market value limitation is warranted. We therefore reverse the judgment of the tax court.

The Commissioner relies primarily on the decision in Millar v. Commissioner, 577 F.2d 212 (3rd Cir.), cert. denied, 439 U.S. 1046, 99 S.Ct. 721, 58 L.Ed.2d 704 (1978). The Millar court rejected a literal reading of footnote 37 in view of what it thought to be the principal reason underlying the Crane decision. The court focused on the following language:

The crux of this case, really, is whether the law permits her to exclude allowable deductions from consideration in computing gain. We have already showed that, if it does, the taxpayer can enjoy a double deduction, in effect, on the same loss of assets.

557 F.2d at 215, quoting Crane, 331 U.S. at 15-16, 67 S.Ct. at 1055. According to the Millar panel, the Supreme Court was primarily concerned that the taxpayer might enjoy some sort of double deduction. The tax court below, as well as the Commissioner on appeal, agreeing with Millar, also identified this concern for double deductions as the principal reason for the Crane holding. They invoke the Crane double deduction language in support of a tax benefit theory: the argument, in essence, is that a taxpayer who has previously enjoyed the benefit of large tax deductions, without placing his own assets at risk, has, by taking those deductions, improved his economic position, thus realizing gain. According to the Commissioner and the tax court, the taxpayer, on disposing of the property, must somehow be made to account for the benefits previously enjoyed.

We do not agree that this concern for double deductions was the principal reason underlying the Crane decision. The Crane language leaves no doubt that the Court thought that Mrs. Crane had improved her financial condition by availing herself of the allowable deductions. But before the Court had even mentioned double deductions, it had already concluded that the Commissioner had properly determined the amount realized. After reaching that conclusion, the Court acknowledged the distinction between statutory income (that which Congress has decided to reach through legislation) and constitutional income (that which Congress has the power to reach, if it chooses to do so). Mrs. Crane had argued in the alternative that she had been taxed on what was not income within the meaning of the sixteenth amendment. The Court responded to this constitutional argument in the last paragraph of its opinion, and in that last paragraph the Court for the first time expressed concern for double deductions. We therefore prefer to read this expression of concern as primarily a response to Mrs. Crane's constitutional argument, and not as the principal justification for the statutory holding that the Court had announced earlier in the opinion. ⁴

There is an even more compelling reason why the fact that a taxpayer has previously enjoyed the benefit of large depreciation deductions is insufficient to justify an expansion of the definition of amount realized. We see, by looking to the Internal Revenue Code, that Congress has already in fact accounted for those previous deductions. According to the Code, "gain" from the sale or other disposition of property is computed by subtracting the "adjusted basis" from the "amount realized." I.R.C. § 1001(a). The "adjusted basis" is the cost of the property adjusted to reflect the depreciation, depletion, and other costs chargeable against the property. I.R.C. § 1016. Thus, any tax benefits that the taxpayer may have received in the form of prior deductions have already been factored into the gain equation through adjustments to basis. Since those deductions have been accounted for through adjustments to basis, it follows logically that they cannot also support an expansion of the definition of amount realized. To account for those deductions twice in the same equation by expanding the definition of amount realized as well as adjusting basis downward would, we think, be taxing the taxpayer twice on the same component of gain. ⁵ The Commissioner's reliance on a theory of tax benefit, then, is misplaced. The Code clearly provides for a "recapture" of the prior deductions, ⁶ but not through its definition of amount realized.

When we look to what the Court said immediately before it announced its conclusion that the Commissioner had properly determined the amount realized, we see that the Court justified its result on a theory of economic benefit, first recognizing that the term "amount realized" could be expanded where an economic benefit equivalent to cash could be identified. The Court began by noting that if Mrs. Crane had been personally liable on the mortgage and the purchaser had either paid or assumed it, the amount so paid or assumed would clearly have been considered a part of the amount realized because Mrs. Crane would have received the benefit of the payment "in 'as real and substantial (a sense)' " as if the money had been paid to her and then paid over by her to her creditors. 331 U.S. at 13, 67 S.Ct. at 1054, citing United States v. Hendler, 303 U.S. 564, 58 S.Ct. 655, 82 L.Ed. 1018 (1938). That proposition and the economic principle from which it derives are indisputable: when a debt on which a taxpayer is personally liable is discharged, the taxpayer is freed from the necessity of paying the obligation with cash or other assets equal in value to the principal amount of the debt. United States v. Kirby Lumber Co., 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131 (1931). What the Court thought followed from that proposition, however, is worth quoting (W)e think that a mortgagor, not personally liable on the debt, who sells the property subject to the mortgage and for additional consideration, realizes a benefit in the amount of the mortgage as well as the boot. [37 If a purchaser pays boot, it is immaterial as to our problem whether the mortgagor is also to receive money from the purchaser to discharge the mortgage prior to sale, or whether he is merely to transfer subject to the mortgage it may make a difference to the purchaser and the mortgagee, but not to the mortgagor. Or put in another way, we are no more concerned with whether the...