FIRST FED. SAV. & LOAN ASS'N OF BRISTOL v. US
| Decision Date | 23 September 1981 |
| Docket Number | No. 147-79T.,147-79T. |
| Citation | 660 F.2d 767 |
| Parties | FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF BRISTOL v. The UNITED STATES. |
| Court | U.S. Claims Court |
John Y. Merrell, McLean, Va., Atty. of record, for plaintiff; John Y. Merrell, Jr. and Timothy J. Callahan, McLean, Va., of counsel.
Israel D. Shetreat, Washington, D. C., with whom was Acting Asst. Atty. Gen., John F. Murray, Washington, D. C., for defendant; Theodore D. Peyser and Donald H. Olson, Washington, D. C., of counsel.
Before FRIEDMAN, Chief Judge, and NICHOLS and KUNZIG, Judges.
ON DEFENDANT'S MOTION FOR SUMMARY JUDGMENT AND PLAINTIFF'S CROSS-MOTION FOR SUMMARY JUDGMENT
This is a suit by a savings and loan association described in Section 593 of the Internal Revenue Code of 1954, to recover overpayment of income taxes for 1975 and 1976, resulting from inclusion in income of rentals on foreclosed property, as required by defendant. The issue is the proper interpretation of § 595 of the Code and the validity of a Treasury Regulation founded on § 595. There is no triable issue of fact. We hold for the plaintiff for reasons to be stated.
Plaintiff, First Federal Savings and Loan Association of Bristol (S & L) is in the business its name implies. It is limited by its charter to making loans secured by real estate, and it is subject to examination and regulation by the Federal Home Loan Bank Board. It is an accrual basis taxpayer and its fiscal year for tax purposes is its calendar year. In spring 1972 it agreed to make and did make a secured construction loan to Downtown Plaza, Inc., to be used to build an apartment complex of seven buildings in Bristol, Virginia. A note of May 1, 1972, was secured by a deed of trust covering the site and the anticipated improvements. In Virginia, a deed of trust is tantamount to what is more generally called a mortgage. The borrower was early in difficulties, but S & L, reluctant to foreclose an unfinished property, carried the loan until February 7, 1974, then foreclosing. It purchased the property itself for $710,000 at the sale, being the only bidder. At that time plaintiff had disbursed $982,000 on the loan. Four buildings and 48 rental units were then completed. Plaintiff rented them, while working to complete the other three buildings and 28 units. It collected rents, incurred expenses related to the rental property (exclusive of depreciation) and profited as follows:
RENTALS RENTAL
YEAR RECEIVED EXPENSES PROFIT
---- -------- -------- ------
1975 $71,274 $34,046 $37,228
1976 72,560 21,955 45,605
Plaintiff paid U.S. income tax on these so-called profits, less the expenses, $17,710 for 1975 and $17,764 for 1976. It is agreed that plaintiff was not required to account for these rents to the debtor. Plaintiff duly requested refunds and the suit here timely follows the Commissioner's denial.
Plaintiff says it commenced looking for a buyer in 1977, but effected a sale only in May 1978. The sale price was $1,237,500, of which $876,259 was allocated to the foreclosed property and $411,241 to the improvements S & L constructed after the foreclosure. This results in a loss on the foreclosed property of $206,000, before adjustment for the rental income, if any is to be made. Plaintiff would use the rental income to reduce this loss and thus pro tanto benefit its bad debt reserve, but it says its tax liability after 1976 would be unaffected because its annual deductions for the bad debt reserve were unaffected by losses within the range here in dispute. This is how § 593 works, apparently. Thus the benefit it claims for 1975 and 1976 pursuant to § 595 is likewise not limited to timing only. Defendant does not assert that the added tax it collected for 1975 and 1976 would, if refunded, be offset by any added tax liability in later years.
The I.R.C. in § 593 designates certain organizations including "* * * any * * * domestic building and loan association" and tells how to calculate their bad debt reserves. We need not consider the approved methods used here as apparently the issue does not turn on them. Section 595 tells what is to happen in case a § 593 organization forecloses the security on a loan. In general, no gain or loss is recognized on the foreclosure, nor is any part of the debt deemed worthless in case the organization itself bids in at the foreclosure sale. Section 595(a). The property continues to have the same characteristics as the secured indebtedness previously had.
* * * Any amount realized by such organization with respect to such property shall be treated for purposes of this chapter as a payment on account of such indebtedness, and any loss with respect thereto shall be treated as a bad debt to which the provisions of section 166 () apply. 26 U.S.C. § 595(b)
The basis of such foreclosed property is the basis of the indebtedness for which it was security. Section 595(c).
The Secretary is authorized to prescribe such regulations as he may deem necessary to carry out the purposes of the section. Section 595(d). The whole of § 595 is attached to this opinion as an appendix.
The Revenue Act of 1962, Pub.L.No.87-834, 76 Stat. 960, added §§ 593 and 595 to the 1954 Code. The purpose was primarily to curtail the special deductions for bad debt reserves which had virtually eaten up the corporate income tax so far as it had applied since 1951 to organizations of the kind involved. S.Rep.No.1881, 87th Cong.2d Sess. 2 U.S.Code Cong. & Ad.News (1962) 3297, 3350. However, the Congress took the occasion also to change the tax treatment of a foreclosure when the lending organization took title to the security. There had been two taxable events: a gain or loss on the foreclosure itself and again on disposition of the property. As the legal definition of an S & L does not contemplate permanent ownership and operation of real property, it was clear that almost invariably, as here, the second event follows the first and determines the real impact of both on the fortunes of the S & L. So the new provision, in effect, collapses two taxable events into one. What the Senate Finance Committee saw as "erratic" tax consequences were avoided. The committee did not expressly state how rents during the S & L's temporary ownership should be dealt with, but did say, at 3350:
Because the foreclosed property is to have the same characteristics as the indebtedness, when property is rented by the mutual thrift organization after foreclosure, no depreciation deduction is to be permitted. However, as explained above, if the property actually depreciates in worth (as contrasted to a mere decline in book value) a charge may be made against the reserve.
The material referred to above indicates a reliance by the committee on the supposed ability of the S & L to safeguard itself by making a charge against the reserve even before it has actually disposed of the foreclosed property. Presumably this charge would sometimes, but not always, have tax consequences. We presume, if plaintiff here had depreciated its foreclosed property on its books (as the committee said it was not to do) that would have had tax consequences in the tax years here involved, but a charge in those years against the bad debt reserve would not have.
It would appear to us, if gross income from rentals is not offset by deduction for depreciation as well as for direct expenses, figures will result that do not fairly reflect taxable income. Hence it seems unlikely the committee would have intended the rents to be taxed yet not allow any depreciation to be offset. Normally, if rent is treated as taxable income, a depreciation allowance is permitted to reduce the amount of the gross rent, since a portion of that gross rent represents a return of capital rather than income. Anomaly is avoided if "amount realized" in the statute and in the above committee report is read to include amounts realized in the form of rentals.
Such an interpretation appears otherwise natural and in accord with the common understanding of the terms. Defendant would limit the "amount realized" to the amount generated by the subsequent resale, deficiency recoveries against the debtor, etc. It may be noted that foreclosing creditors may under local law be accountable to the debtor for the rentals collected. If that occurs, the amounts realized as rental are exactly and literally "payments on the debt" in the statutory terms when so applied. Neither the statute nor the legislative history treat as making any difference, whether or not the debtor is entitled to such accounting for rentals.
The language of the statute is extremely broad. It provides that "any amount realized * * * with respect to" (emphasis supplied) the foreclosed property should be treated as a payment on account of the indebtedness. It is not limited, as the defendant and the regulation upon which it relies (see infra at 6) would restrict it, to "an amount representing a recovery of capital." Moreover, unlike section 1001 of the Code, which refers to the amount realized "from the sale or other disposition of property," § 595 uses the broader phrase amount realized "with respect to" the property. On its face, this provision covers the rents the plaintiff received from the property.
The fact that the statute uses the word "realized" is not inconsistent with this conclusion. The word is not here used in a restricted sense, but rather as meaning "received." Both the House and Senate Reports so indicate: "amounts received by the mutual savings institution subsequent to the foreclosure are to be treated as payments on the indebtedness." S.Rep.No.1881, 87th Cong., 2d Sess. 47 (1962), reprinted in 1962 U.S.Code, Cong. & Ad.News 3297, 3350; H.R.Rep.No.1447, 87th Cong., 2d Sess. 37 (1962).
Defendant made some effort to persuade that "amount realized" is a technical term or words of art that, in this context...
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