Seymour v. Comm'r of Internal Revenue
| Decision Date | 05 November 1997 |
| Docket Number | No. 2575–96.,2575–96. |
| Parties | John L. SEYMOUR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Thomas J. Thomas, for petitioner.
Leonard T. Provenzale, for respondent.
P deducted the amount of interest paid to his former spouse on an indebtedness which he incurred incident to their divorce. P claimed that the indebtedness was properly allocable to investment, passive activity, and qualified residence indebtedness based on certain assets acquired pursuant to a decree of divorce. R disallowed such deduction on the ground that sec. 1041, I.R.C., requires P's interest expense to be characterized as personal interest under sec. 163(h)(1), I.R.C.
Held: Sec. 1041, I.R.C., has no relevance to the proper characterization of interest on indebtedness incurred incident to divorce.
Respondent determined deficiencies in petitioner's Federal income taxes and additions to tax as follows:
After concessions, the issues for decision are: (1) Whether interest petitioner paid to his former spouse pursuant to a decree of divorce is nondeductible personal interest under section 163(h)(1); 1 and (2) whether petitioner is liable for the additions to tax under section 6654(a) for the taxable years 1992 and 1993.
Some of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulation of facts, and stipulation of settled issues are incorporated herein by this reference. Petitioner resided in Palm Beach Gardens, Florida, at the time-he filed his petition.
By Final Judgment of Dissolution of Marriage dated July 20, 1987 (the divorce decree), the Florida Circuit Court of the Fifteenth Judicial Circuit, in and for Palm Beach County, dissolved the marriage between petitioner and Katherine S. Seymour. In connection with their divorce, petitioner and Mrs. Seymour entered into a Separation and Property Settlement Agreement on July 17, 1987 (the property settlement agreement), which was subsequently incorporated into the divorce decree.
The property settlement agreement required that Mrs. Seymour convey to petitioner the following assets:
A. The wife's Class A and Class B stock in Pepsi–Cola Bottling Company of Selma, Inc.;
B. The wife's interest in the Pepsi–Cola land and building located in Selma, Alabama;
C. The wife's interest in the marital homeplace located at 14732 Palmwood Road, Palm Beach Gardens, Florida.
Under the terms of the property settlement agreement, petitioner was required to pay to Mrs. Seymour the sum of $925,000,2 payable as follows:
A. $300,000 within thirty (30) days of the date of the execution of this agreement in current funds;
B. The balance of $625,000 over a period of ten (10) years bearing interest at the rate of 10%. The first three (3) years shall be payable interest only in equal semi-annual payments payable June 30 and December 31 each year. The first payment shall be due December 31, 1987. The remaining seven (7) years of the term of the note will be paid by the husband in equal semiannual payments payable June and December each year of principal and interest. * * *
On January 1, 1988, petitioner executed a promissory note naming Mrs. Seymour as the holder and containing payment provisions similar to those reflected in the property settlement agreement.3 To secure the promissory note, petitioner conveyed to Mrs. Seymour a mortgage deed on the residence located in Palm Beach Gardens, Florida. The mortgage deed conveyed to Mrs. Seymour was subordinate to a preexisting mortgage on the property.
During the years in issue, petitioner made the following payments (consisting of principal and interest) to Mrs. Seymour:
+--------------------------------------------+
¦Date ¦Principal ¦Interest ¦Total Payment¦
+--------+----------+----------+-------------¦
¦06/30/92¦$44,642.86¦$26,785.71¦$ 71,428.57 ¦
+--------+----------+----------+-------------¦
¦12/31/92¦44,642.86 ¦24,553.57 ¦69,196.43 ¦
+--------+----------+----------+-------------¦
¦Total ¦$89,285.72¦$51,339.28¦$140,625.00 ¦
+--------+----------+----------+-------------¦
¦06/30/93¦$44,642.86¦$22,321.43¦$ 66,964.29 ¦
+--------+----------+----------+-------------¦
¦12/31/93¦44,642.86 ¦20,089.29 ¦64,732.15 ¦
+--------+----------+----------+-------------¦
¦Total ¦$89,285.72¦$42,410.72¦$131,696.44 ¦
+--------------------------------------------+
Petitioner failed to file timely Federal income tax returns for the taxable years 1992 and 1993. On November 13, 1995, respondent issued separate notices of deficiency to petitioner for the 1992 and 1993 taxable years. On February 9, 1996, petitioner submitted Federal income tax returns (Forms 1040) for the taxable years 1992 and 1993. On Schedules A of the Forms 1040, petitioner deducted $51,339.28 and $42,410.72 as investment interest for 1992 and 1993, respectively.
OPINIONAfter concessions, the principal issue in this case involves the application of sections 163 and 1041 to interest that petitioner paid in 1992 and 1993 on indebtedness to his former spouse. Section 163(a) provides the general rule that there shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness. However, as an exception to this general rule, section 163(h)(1) provides that in the case of a taxpayer other than a corporation, no deduction shall be allowed for personal interest which is paid or accrued during the taxable year. Pursuant to section 163(h)(2), personal interest does not include interest which is investment interest, interest which is taken into account under section 469 in computing income or loss from a passive activity of the taxpayer (passive activity interest), or qualified residence interest.4
The term “investment interest” is defined to mean interest “which is paid or accrued on indebtedness properly allocable to property held for investment.” Sec. 163(d)(3)(A). However, investment interest does not include any qualified residence interest or any interest taken into account under section 469 in computing income or loss from a passive activity of the taxpayer. Sec. 163(d)(3)(B). In general, the deduction for investment interest is limited to the noncorporate taxpayer's net investment income for the taxable year. Sec. 163(d)(1).
Interest allocated to a passive activity within the meaning of section 469 will be taken into account in determining the income or loss from such activity and, therefore, is not subject to the limitations of section 163(h). Sec. 163(h)(2)(C). However, the interest expense will be subject to possible disallowance under the passive activity loss limitation of section 469.
For the purposes of applying the passive loss limitation of section 469 and the nonbusiness interest limitations of section 163(d) and (h), section 1.163–8T, Temporary Income Tax Regs., 52 Fed.Reg. 24999 (July 2, 1987), prescribes rules for the proper allocation of an interest expense. In general, an interest expense is allocated in the same manner as the related debt is allocated; i.e., tracing the proceeds of the debt. Sec. 1.163–8T(a)(3), Temporary Income Tax Regs, supra. Section 1.163–8T(c)(1), Temporary Income Tax Regs., 52 Fed.Reg. 25000 (July 2, 1987), provides:
Debt is allocated to expenditures in accordance with the use of the debt proceeds and, except as provided in paragraph (m) of this section, interest expense accruing on a debt during any period is allocated to expenditures in the same manner as the debt is allocated from time to time during such period. Except as provided in paragraph (m) of this section, debt proceeds and related interest expense are allocated solely by reference to the use of such proceeds, and the allocation is not affected by the use of an interest in any property to secure the repayment of such debt or interest. * * *
If the taxpayer incurs a debt in consideration for the sale or use of property, or takes property subject to a debt, and no debt proceeds are disbursed to the taxpayer, the debt is treated as if the taxpayer used an amount of the debt proceeds equal to the balance of the outstanding debt to make an expenditure for such property. Sec. 1.163–8T(c)(3)(ii), Temporary Income Tax Regs., 52 Fed.Reg. 25001 (July 2, 1987).
Petitioner contends that the interest he paid to Mrs. Seymour is properly allocable to the assets he received from her incident to their divorce. Respondent contends that because the assets were transferred incident to a divorce, the treatment of the transaction under section 1041 prevents the allocation of petitioner's indebtedness to such assets, and the interest should be allocated to his personal obligation and, thus, characterized as nondeductible personal interest under section 163(h)(1).
Section 1041(a) provides that no gain or loss shall be recognized on a transfer of property from an individual to a spouse, or former spouse, if the transfer is incident to divorce. See Balding v. Commissioner, 98 T.C. 368, 370, 1992 WL 62026 (1992); Gibbs v. Commissioner, T.C. Memo.1997–196. In the case of such a transfer, section 1041(b) provides that the property shall be treated as acquired by the transferee by gift and the basis of the property shall be the adjusted basis of the transferor. Respondent appears to argue that, since section 1041(b) provides that transfers incident to a divorce are to be treated as gifts, any debt incurred with respect to such transfers cannot be allocated to the property acquired. We do not agree.
In Gibbs v. Commissioner, supra, the taxpayer failed to include as income the amount of interest she received from her former spouse pursuant to a decree of divorce. Although the taxpayer conceded that a portion of each payment she received represented interest, she argued...
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