Hadley Falls Trust Co. v. United States

• Decision Date: 29 March 1940
• Docket Number: No. 3434.,3434.
• Citation: 110 F.2d 887
• Parties: HADLEY FALLS TRUST CO. v. UNITED STATES.
• Court: U.S. Court of Appeals — First Circuit

110 F.2d 887 (1940)

HADLEY FALLS TRUST CO. v. UNITED STATES.

No. 3434.

Circuit Court of Appeals, First Circuit.

March 29, 1940.

Howard C. Connor and Ward F. Porter, both of Boston, Mass., for appellant.

Robert N. Anderson, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Arthur A. Armstrong, Sp. Assts. to Atty. Gen., on the brief), for appellee.

Before WILSON and MAGRUDER, Circuit Judges, and BREWSTER, District Judge.

BREWSTER, District Judge.

The petitioner-appellant (hereinafter referred to as the "plaintiff") brought this action to recover refunds of income taxes for the years 1930 and 1931.

1930

The refund claimed for this year is $4,402.69. In 1927 plaintiff acquired a second mortgage on real estate subject to a first mortgage of $100,000. The second mortgage secured a note in the amount of $65,000, given by the Western Massachusetts Realty Company. The Board of Directors of that Company, on November 8, 1930, voted to turn the property over to the plaintiff, due to the fact that they were unable to meet their mortgage obligations on it.

Pursuant to Massachusetts Statute (Mass.G.L., c. 244, sec. 1), entry to foreclose the second mortgage for breach of the condition thereof was duly made on the property December 1, 1930. The fair market value as of that date was $123,000. The plaintiff claims a deduction of $42,000, the difference between $165,000 and $123,000. This claim is based on section 23 of the Revenue Act of 1928, 26 U.S.C. A.Int.Rev.Acts, the pertinent provisions of which are the following:

"Sec. § 23. Deductions from Gross Income

"In computing net income there shall be allowed as deductions:

* * *

"(f) Losses by Corporations. In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise. * * *

"(j) Bad Debts. Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part."

It is the plaintiff's contention that the entry to foreclose resulted in a realized loss¹ within the statute, especially in view of the remote possibility of a redemption by the mortgagor. We cannot accept this contention as sound.

Upon the plaintiff rests the burden of proving not only that it sustained a loss in 1930, but the extent of that loss. Burnet v. Houston, 283 U.S. 223, 51 S.Ct. 413, 75 L.Ed. 991. Moreover, the loss must be evidenced by a closed and completed transaction. Regulation 74, Art. 171; United States v. S. S. White Dental Mfg. Co., 274 U.S. 398, 47 S.Ct. 598, 71 L.Ed. 1120; Jones v. Commissioner, 9 Cir., 103 F.2d 681; Howard v. Commissioner, 6 Cir., 56 F.2d 781; Burdan v. Commissioner, 3 Cir., 106 F.2d 207. See also Burnet v. Huff, 288 U.S. 156, 53 S.Ct. 330, 77 L.Ed. 670.

In Burdan v. Commissioner, supra, 106 F.2d at page 209, the court said:

"A deduction may not be allowed for anticipated losses even though they may appear to be imminent."

The plaintiff has failed to establish the amount of its loss, or that it was evidenced by a completed transaction.

All that the plaintiff had done in 1930 was to make an entry into possession. Under Massachusetts law, entry by the mortgagee to foreclose results neither in any transfer of title to the mortgagee nor in any reduction of the mortgage indebtedness. The mortgagee's going into possession merely increases the security. Mass. G.L., c. 244, sec. 1; West v. Chamberlin, 8 Pick. 336, 25 Mass. 336, 338; Levin v. Century Indemnity Co., 279 Mass. 256, 259, 181 N.E. 223. In the case of foreclosure by entry, the mortgage debt is automatically discharged at the end of the three-year redemption period to the extent of the value of the property at that time. Morse v. Merritt, 110 Mass. 458, 460; Draper v. Mann, 117 Mass. 439, 441.

If there is a redemption within the three-year period it is provided by Mass. G.L.(Ter.Ed.) c. 244, sec. 20, that the mortgagee in possession must account for the rents and profits received by him and shall "be allowed for all amounts expended in reasonable repairs and improvements, for all lawful taxes and assessments paid and for all other necessary expenses in the care and management of the land. A balance of such account, if due from him, shall be deducted from the debt due on the mortgage; if due to him, shall be added to the debt, and paid or tendered as such". Furthermore, where actual foreclosure has taken place, the determination of the deficiency judgment depends upon a similar accounting between mortgagor and mortgagee. Newall v. Wright, 3 Mass. 138, 3 Am.Dec. 98; Amory v. Fairbanks, 3 Mass. 562; City Institution for Savings v. Kelil, 262 Mass. 302, 159 N.E. 731; Beal v. Attleborough Savings Bank, 248 Mass. 342, 142 N.E. 789.

There is nothing in the Massachusetts law, therefore, which compels the conclusion that a mortgagee's entry to foreclose in itself evidences a complete or partial worthlessness of the mortgage debt. It was still possible, under the provisions of Massachusetts law, for the mortgagor in the present case to redeem within a period of three years after the plaintiff entered in 1930. Whether loss to the mortgagee became inevitable in that year really must depend upon whether it could be said, upon the evidence presented, that in 1930 the chances of a future redemption by the mortgagor or recovery of a collectible deficiency judgment against him could fairly be dismissed as negligible. The burden of showing this was upon the taxpayer. Helvering v. Taylor, 293 U.S. 507, 514, 55 S. Ct. 287, 79 L.Ed. 623; Burnet v. Houston, 283 U.S. 223, 227, 51 S.Ct. 413, 75 L.Ed. 991.

The only evidence contained in the record on this issue consists of the resolution of the directors of the Western Mass. Realty Co., the mortgagor, that they were turning over the property because they were unable to meet the mortgage thereon; the record also contains certificates of condition filed by the mortgagor corporation with the State Commissioner of Corporations and Taxation which show that in 1930, 1931 and 1932, the mortgagor's liabilities exceeded its assets. It cannot be said, however, that the District Court should have held that this evidence alone conclusively eliminated the reasonable possibility of redemption by either the mortgagor or its creditors, or that this evidence alone made it clear in 1930 that the mortgagee had no reasonable expectation of being able to recover a deficiency judgment, collectible in whole or in part, against the mortgagor after the expiration of the three-year redemption period.

The taxpayer urges that the action of the mortgagor's directors constituted an "abandonment" of the property, and cites in support of its contention Rogers v. Commissioner, 9 Cir., 103 F.2d 790. In that case, there was a conceded relinquishment of the mortgaged property to the mortgagee in exchange for cancellation of the mortgage debt. The mortgagor parted with all right, title and interest in the land — in exchange, the mortgagee handed over the mortgage notes to the mortgagor. The court held that this gave rise to a deductible loss to the mortgagor. In the case at bar, there is nothing in the record which evidences any agreement, express or implied, between the mortgagor and the mortgagee, that the mortgagee's entry to foreclose consummated a final, complete transfer of the property from the mortgagor to the mortgagee. Consequently we can find no justification in the record for the plaintiff's theory that the mortgagor "abandoned" the property in favor of the mortgagee, and that the mortgagee reciprocated by abandoning the mortgage debt.

We conclude, therefore, that the court below did not err in holding that the taxpayer was not entitled to any deduction in its 1930 tax liability on account of the foreclosure entry upon the Western Massachusetts Realty Company property.

1931

The plaintiff seeks to recover a refund of 1931 taxes in the sum of $14,583.69. The controversy arises over the action of the Commissioner in refusing to allow as deductions (1) losses claimed to result from foreclosure, by entry, of two mortgages; (2) losses claimed to result from foreclosure by sale of two mortgages; (3) expenses incurred in connection with all of said mortgages; and (4) certain so called bad debts.

First: On June 1, 1931, the plaintiff held two real estate mortgages securing notes aggregating $120,000. In March and May, 1931, plaintiff entered upon the mortgaged premises for the purpose of foreclosure. There was no sale under the power of sale in the mortgages. The fair market value at the time of the entries was $102,500. Plaintiff contends that it is entitled to a deduction as a loss allowable under 23(f) of the Revenue Act of 1928. The plaintiff is not entitled to this deduction. What we have said above respecting the 1930 tax fully disposes of this issue. The record is even more barren on the question of reasonable possibility of redemption by the mortgagors or of collecting deficiencies from them.

Second: On January 1, 1931, plaintiff had two other mortgages on real estate, aggregating $55,500, which mortgages were foreclosed in August, 1931, by the exercise of the power of sale contained therein. Plaintiff bid in the properties for $56,000. The fair market values of these properties at the time of sale was $49,200. A loss measured by the difference between the fair market values and the face of the mortgage indebtedness is claimed as a deduction. The plaintiff relies not only upon the statute but also upon Article 193 of Regulations 74, which contains the following provision:

"Uncollectible deficiency upon sale of mortgaged or pledged property. — Where mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt; and...