Brown v. United States, 6548.

• Decision Date: 02 March 1938
• Docket Number: No. 6548.,6548.
• Citation: 95 F.2d 487
• Parties: BROWN v. UNITED STATES.
• Court: U.S. Court of Appeals — Third Circuit

95 F.2d 487 (1938)

BROWN v. UNITED STATES.

No. 6548.

Circuit Court of Appeals, Third Circuit.

March 2, 1938.

Weill, Blakely & Nesbit, of Philadelphia, Pa. (Alfred S. Weill, of Philadelphia, Pa., Hugh Satterlee, of Washington, D. C., and Thorpe Nesbit, of Philadelphia, Pa., of counsel), for appellant.

James W. Morris, Asst. Atty. Gen., and Sewall Key, Lee A. Jackson, and Milton Carr Ferguson, Sp. Assts. to Atty. Gen., Alexander Tucker, of Washington, D. C., J. Cullen Ganey, U. S. Atty., of Bethlehem, Pa., and Thomas J. Curtin, Asst. U. S. Atty., of Philadelphia, Pa., for the United States.

Before DAVIS and THOMPSON, Circuit Judges, and DICKINSON, District Judge.

DICKINSON, District Judge.

The plaintiff-appellant made an investment in a mortgage of one John J. Dougherty, secured upon premises known as the "Four Corners Property." The mortgage was for $100,000, and was assigned to the appellant by a trust company for a consideration of about $98,000. Incidentally the assignor guaranteed the mortgage principal and interest. The mortgagor failed and died hopelessly insolvent, and the trust company guarantor also became insolvent. On default the mortgage was foreclosed and the mortgaged premises bought in by the mortgagee for the nominal sum of $50 — a sum insufficient to pay costs. The date of sale was June 6, 1932. The mortgage was in the usual form of one to secure the payment of the obligor's bond for $100,000. A deficiency judgment, if recovered against the mortgagor, is treated as uncollectible as would likewise be a judgment against the guarantor. The mortgaged premises are, however, admitted to have "a fair market value" of something more than $63,000. On the basis of a debt claim against the mortgage debt obligor and his guarantor, the loss of the appellant is a total one of about $98,000. On the basis of a mortgage investment loss it is about $35,000. The appellant made no claim for a loss in his 1932 tax return because he thought he could make no claim until he had sold the mortgaged property. He discovered his error within the time allowed for an amended return, and made his claim. It is admitted that if he had the right to have his loss deducted from his taxable income for the year 1932 he should have judgment; otherwise not.

The proposition is likewise accepted that it is not enough that the taxpayer should have met with a loss; the loss must be such a one as the taxing laws allow to be deducted. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 54 S.Ct. 788, 78 L.Ed. 1348.

The defendant asserts that although this taxpayer has met with a loss, it is not deductible because of his failure to comply with the formalities prescribed for its ascertainment. This thus becomes the only question arising on this appeal.

The applicable statute is the Revenue Act of 1932, c. 209, 47 Stat. 169. Clause (e), section 23, of the act, 26 U.S.C.A. § 23(e), and note, is devoted to "Losses by Individuals." Such is the loss here. These are classified as of three types: (1) Those incurred in trade or business. (2) Those "incurred in any transaction entered into for profit, though not connected with the trade or business." (3) Those which may be described as physical damage to property.

The appellant was not engaged in any trade or business, and this case belongs to the second class. Clause (j) of section 23, 26 U.S.C.A. § 23(k) and note, is devoted to "Bad Debts," and authorizes the Commissioner to allow for them if "debts ascertained to be worthless and charged off within the taxable year." Whether the appellant's loss is a "Bad Debt" will be discussed later. The Regulations adopted to aid in the administration of this tax law provide for the very fact situation here presented in Regulation 77 — Article 193. It is headed, "Uncollectible deficiency upon sale of mortgaged or pledged property." The Regulation is that "where mortgaged or pledged property is lawfully sold for less than the amount of the debt and the mortgagee or pledgee ascertains that" (the unpaid part of the debt) "is uncollectible and charges it off," he may deduct it. There is an added clause: "In addition where the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between (the debt) and the fair market value of the property."

It is further provided that: "The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary." This certainly means that had the taxpayer made claim in the 1932 tax return for a total loss on the theory that the mortgaged property was worth only $50, "clear and convincing proof" might have been offered that it was worth something more than $63,000 and the loss determined. The admission of the taxpayer would be such proof. There is a similar like class made of "Bonds."

All this is admitted by the appellee, but it says no claim for this loss was made in the return for the taxable year 1932, and it can be allowed in the amended return only if the loss was ascertained and charged off within the 1932 taxable year, and this loss, although suffered, was not ascertained or at least not so charged off. The learned trial judge held that the loss or bad debt was not "charged off" by the taxpayer within the meaning of the revenue statute, and hence gave judgment for the appellee.

Incidentally much time and space has been devoted in the oral argument and printed briefs to the question whether the failure of the taxpayer to realize on this mortgage investment resulted in a bad debt or a loss. The truth is that a mortgage is amphibious. When given, as is usual and as here, to secure the payment of a bond, the bond is a debt, and if worthless is a bad debt. On the other hand, a mortgage is a conveyance. It is conditional, but none the less a conveyance, which becomes absolute if the grantor does not pay his bond. This right to redeem is called the mortgagor's equity of redemption which may be foreclosed and in consequence gone. The very purpose of a foreclosure proceeding is to put an end to the right to redeem and thus to make the conveyance to the mortgagee absolute and unconditional. In this view a mortgage is an investment in real estate. It is idle, however, to spend time over this question because the Regulations classify cases such as this as "bad debts," and the District Court so ruled it to be. It is a "bad debt" loss. The sole question is whether it was "ascertained and charged off" within the taxable year.

We should be reminded that the Revenue Act distinguishes between bad debts incurred in the course of a trade or business and bad debts incurred in transactions in which the taxpayer was not engaged in any trade or business. It is here that we think the learned trial judge was inadvertently led into error. He has...