Midland Mut. Life Ins. Co. v. Commissioner of Int. Rev., 7001.

• Decision Date: 06 May 1936
• Docket Number: No. 7001.,7001.
• Parties: MIDLAND MUT. LIFE INS. CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

83 F.2d 629 (1936)

MIDLAND MUT. LIFE INS. CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 7001.

Circuit Court of Appeals, Sixth Circuit.

May 6, 1936.

Earl F. Morris, of Columbus, Ohio, and Edw. W. Merkel, of Cincinnati, Ohio (F. J. Wright, of Columbus, Ohio, Joseph C. Dinsmore, of Cincinnati, Ohio, Arnold, Wright, Purpus & Harlor and Richard H. LeFevre, all of Columbus, Ohio, and Dinsmore, Shohl, Sawyer & Dinsmore, of Cincinnati, Ohio, on the brief), for petitioner.

Helen R. Carloss, of Washington, D. C. (Frank J. Wideman, Sewall Key, Norman D. Keller, and Louise Foster, all of Washington, D. C., on the brief), for respondent.

Before MOORMAN, HICKS, and SIMONS, Circuit Judges.

SIMONS, Circuit Judge.

The sole question involved in this review is whether accrued interest on defaulted loans secured by mortgages constitutes taxable income to the mortgagee by virtue of its having bid in the properties at foreclosure sales for the debts and interest, when the fair market value of the properties was less than the bids. The respondent made a determination of a deficiency in the petitioner's computation of net taxable income for 1930 by adding to such net income the accrued interest on certain mortgage loans in that year foreclosed. The Board of Tax Appeals sustained the determination, notwithstanding undisputed evidence that fair value was less than the total of the debt, including interest.

The petitioner is a life insurance company, and kept its books on a calendar year cash basis. Only those payments of interest which were actually received were entered thereon. In 1930 it foreclosed certain Michigan and Ohio mortgages, and at the sales bid in the various parcels for amounts equalling the principal of the loans plus the accrued interest. Its purpose in so doing was to secure itself against loss in the event of redemption; the local law in each case making provision for such redemption by the mortgage debtor. Upon receipt of title to mortgaged property, the petitioner transferred the investment on its books from the mortgage loan account to the real estate account, and carried it upon its books in an amount equalling the principal of the loan, plus cost of foreclosure, but exclusive of interest. No unpaid interest was carried as an asset either in the petitioner's annual statement or in reports to insurance departments. The bids in respect to the real estate here involved were made without regard to the actual value of the property, and at each sale the petitioner was the only bidder.

The deficiencies were asserted by the respondent, determined by the Board, and are now supported upon review on the ground that a bid at foreclosure sale by the mortgagee establishes the market for the particular property sold and is determinative as to receipt of income by the mortgagee. This is because the legal effect of such sale is said to be the same as though the mortgagee paid the full amount of its bid in cash and then received in cash the full amount of its debt, so that interest is received by it in cash or its equivalent. This view is supported, not only by prior decisions of the Board, but by the Court of Claims in National Life Insurance Co. v. United States, 4 F.Supp. 1000, certiorari denied Lucey v. United States, 291 U.S. 683, 54 S.Ct. 560, 78 L.Ed. 1070, and by the Court of Appeals of the Eighth Circuit in Helvering, Com'r, v. Missouri State Life Insurance Co., 78 F.(2d) 778, 780.

With profound deference to the courts which have considered the problem, we are unable to accept their reasoning. Whatever may be the legal effect of a foreclosure sale upon the passing of title and the extinguishment of the mortgage debt, the fact indisputably remains that, when the mortgagee buys in the property, he does not pay cash. The law permits him to set off the debt against the obligation created by his bid. This distinction is vital in determining whether he has received income. Without possessing the debt, the mortgagee would not bid. He is primarily a lender and a purchaser only through necessity. To say that he pays cash and receives cash is to fly in the face of the realities. A mortgage lien upon property of a defaulting mortgagor is generally worth no...