Kirschenmann v. CIR

• Decision Date: 12 November 1973
• Docket Number: No. 72-1730.,72-1730.
• Citation: 488 F.2d 270
• Parties: Walter KIRSCHENMANN et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

488 F.2d 270 (1973)

Walter KIRSCHENMANN et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 72-1730.

United States Court of Appeals, Ninth Circuit.

November 12, 1973.

Curtis Darling (argued), Darling & Maclin, Bakersfield, Cal., for petitioners-appellants.

Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Michael L. Paup, Attys. (argued), Tax Div., U. S. Dept. of Justice, Washington, D.C., Lee H. Henkel, Jr., Acting Chief Counsel, Internal Revenue Service, Washington, D.C., for respondent-appellee.

Before HUFSTEDLER and WRIGHT, Circuit Judges, and EAST, District Judge.^*

OPINION

EUGENE A. WRIGHT, Circuit Judge:

In this case we must interpret Treasury Regulation § 1.453-4(c) (1958) to determine whether taxpayers may report their gain from the sale of a farm using the installment sale method of Int.Rev. Code § 453. The decision turns on whether the taxpayers' selling expenses are an adjustment to their basis in the property. The Tax Court, 57 T.C. 524, held that they were not and that the sale did not qualify for § 453 installment treatment. We reverse.¹

I

Section 453 permits taxpayers to spread the gain from an installment sale of real property proportionately over the years in which payments are received rather than to recognize the entire gain in the year of sale. For the sale to qualify for installment treatment, payments received in the year of sale must comprise less than 30 percent of the selling price. Treas.Reg. § 1.453-4(c) provides that a mortgage assumed by the purchaser, to the extent that it exceeds the seller's adjusted basis, counts as a payment in the year of sale.

II

                   In 1965 the taxpayers sold the farm in a transaction that is summarized
                   thus
                  (1) Cost of property to taxpayers          $304,552.22
                    Minus Depreciation claimed by
                      taxpayers prior to sale                $206,042.86
                   Equals Taxpayers' Depreciated
                      Basis                                  $ 98,509.36
                  (2) Commissions and other costs incurred
                    by taxpayers in making
                    the sale                                 $ 23,378.42
                  (3) Cash paid by purchaser                 $ 80,011.54
                    Plus Mortgage on the property
                      assumed by purchaser                   $160,000.00
                    Plus Purchaser's note payable
                      over period of years                    $191,988.46
                   Equals Total selling price                            $432,000.00
                  In their 1965 and 1966 tax returns, taxpayers reported $118,123.76 as
                payments in the year of sale, using the computations
                  (1) Taxpayers' Depreciated Basis           $ 98,509.36
                    Plus Selling costs              $ 23,378.42
                    Equals Taxpayers' Adjusted Basis                    $121,887.78
                  (2) Mortgage Assumed by Purchaser          $160,000.00
                    Minus Taxpayers' Adjusted Basis  $121,887.78
                    Equals Excess of Assumed Mortgage
                    over Basis                                                   $ 38,112.22
                  (3) Excess of Assumed Mortgage over
                      Basis                                    $ 38,112.22
                    Plus Cash payment                 $ 80,011.54
                    Equals Payment in year of sale                      $118,123.76
                Since $118,123.76 is less than 30 percent of the total selling price
                ($118,123.76/$432,000.00 = .27), taxpayers utilized the installment
                provisions of § 453
                The Commissioner disallowed taxpayers' inclusion of selling costs in
                their adjusted basis and computed the payment in the year of sale thus
                  (1) Mortgage Assumed by Purchaser           $160,000.00
                    Minus Taxpayers' Adjusted Basis
                      without selling costs                   $ 98,509.36
                    Equals Excess of Assumed Mortgage
                      over Basis                              $ 61,490.64
                

                  (2) Excess of Assumed Mortgage
                    over Basis                               $ 61,490.64
                    Plus Cash Payment               $ 80,011.54
                    Equals Payment in year of sale  $141,502.18
                Since $141,502.18 is more than 30 percent of the selling price ($141,-502.18/$432,000.00 = .33), the Commissioner disallowed taxpayers' use
                of installment reporting.
                The Commissioner and taxpayers agree that selling costs reduce the
                taxable gain from the sale. The Commissioner would offset selling costs
                directly against the selling price and then subtract adjusted basis
                (without selling costs) to compute gain:
                    Selling price                   $432,000.00
                    Minus Selling costs as a direct
                      offset                          $ 23,378.42
                    Minus Adjusted basis without
                      selling costs                   $ 98,509.36
                    Equals Total Taxable Gain                             $310,112.22
                Taxpayers obtain the same total taxable gain in their computations by
                including selling costs in their adjusted basis:
                    Selling price                    $432,000.00
                   Minus Adjusted Basis including
                      selling costs                  $121,887.78
                    Equals Total Taxable Gain               $310,112.22
                

The only difference between the two approaches is the method by which selling costs reduce the total taxable gain. The only tax consequence is the size of the payment in the year of sale. This affects both the taxpayers' eligibility for installment reporting under the 30 percent test of § 453 and the proportionate amount of gain that must be recognized in the year of sale.

We are left with the narrow question of whether selling costs are an adjustment to the seller's basis or a subtraction from the total selling price. We hold that they are an adjustment to the seller's basis in the property.

III

Int. Rev. Code § 1011(a) defines "adjusted basis" as follows:

The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis cost² . . . adjusted as provided in section 1016.

§ 1016(a) provides that:

Proper adjustment in respect to the property shall in all cases be made —

(1) for expenditures, receipts, losses, or other items, properly chargeable to capital account. . . . Emphasis added.

The Tax Court, relying on Dwight v. Ward, 20 T.C. 332, 341-342 (1953), affd. 224 F.2d 547 (9th Cir. 1955), held that selling expenses are not "properly chargeable to capital account," but rather that they are an "offset against the gross profit from the sale" as "expenditures `made in connection with the sale of a capital asset.'" The Commissioner also cites a line of authority in support of the proposition that selling costs are an "offset" against gross profit rather than an adjustment to basis as an item "properly chargeable to capital account." See, e. g., Spreckels v. Commissioner of Internal Revenue, 315 U.S. 626, 629, 62 S.Ct. 777, 86 L.Ed. 1073 (1942); Godfrey v. Commissioner of Internal Revenue, 335 F.2d 82, 85-86 (6th Cir. 1964); Treas. Reg. § 1.263(a)-2(e); 4A Mertens, Law of Federal Income Taxation, § 25.26.

These authorities characterize selling expenses as an "offset" against either the selling price or the gain from the sale. The Commissioner relies on the use of the term "offset," arguing that an "offset" is a direct deduction rather than an adjustment to basis. But an offset can be effected either directly, through a direct deduction from gain, or indirectly, through an adjustment to basis. The use of the term "offset" in these authorities does not help us to decide the method by which the offset is to be accomplished.³

More important, none of these authorities addresses the problem now before us. They merely hold that selling expenses are not deductible against ordinary income but rather must be deducted from the capital gain with which they are associated. None of these authorities considers whether the deduction against capital gain is effected by an adjustment to basis or by a direct subtraction from the gain itself, and in none of the cases would the difference between the two approaches have had any tax consequences. Even if the term "offset" carried the implications that the Commissioner claims, it is unlikely that the authors of the authorities referred to had considered the difference between an adjustment to basis and a direct subtraction from gain. Surely, they did not have the problems of § 453 in mind when the term "offset" was selected.⁴

While the "offset" language of these cases does not support the Commissioner's position, their holdings do support the taxpayers' position that selling costs are an adjustment to basis as an item "properly chargeable to capital account." The rationale of these cases is that since selling expenses are capital expenses, they are not deductible from ordinary income. If we were to adopt the Commissioner's position, we would be required to hold that while selling expenses are capital expenses, they are not "properly chargeable to capital account." This would be a strained interpretation of a "capital account" under § 1016, and we decline to adopt it. As a capital expense, selling costs are "properly chargeable to capital account" and are therefore an adjustment to basis under § 1016.

IV

The Tax Court also relied on the fact that the taxpayers' position would permit them to fully deduct selling expenses in the year of sale rather than spread the deduction over the years in which payments are made. The Tax Court felt that such a consequence of taxpayers' position is inconsistent with Treas. Reg. § 1.453-1(b)(1) (1963) and the legislative intent of § 453.

Treas. Reg. § 1.453-1(b)(1) provides that:

Gross profit . . . is reduced by commissions and other selling expenses for purposes of determining the proportion of installment payments returnable as income.

This provision has the effect of spreading the deduction of selling expenses proportionately over the years in which payments are received. In upholding a predecessor of Treas. Reg. § 1.453-1(b)(1), the Board of Tax Appeals stated:

The effect of this method of computation is that in cases where the taxpayer elects to project the profit realized into years beyond that in which the sale is made, the expenses incident to the

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