Quijano v. United States

USCA1 Opinion









UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT

____________________

No. 96-1053

CARLOS J. QUIJANO AND JEAN M. QUIJANO,

Appellants,

v.

UNITED STATES OF AMERICA,

Appellee.

____________________


APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MAINE

[Hon. Gene Carter, U.S. District Judge] ___________________

____________________

Before

Cyr, Circuit Judge, _____________

Aldrich, Senior Circuit Judge, ____________________

and Gertner,* U.S. District Judge. ___________________

____________________


Paula N. Singer, with whom Robert S. Grodberg and Vacovec, _________________ ____________________ ________
Mayotte & Singer were on brief for appellants. ________________
Kenneth W. Rosenberg, Attorney, Tax Division, Department of ______________________
Justice, with whom Jay P. McCloskey, United States Attorney, Loretta _________________ _______
C. Argrett, Assistant Attorney General, Gary R. Allen and Richard __________ ______________ _______
Farber, Attorneys, Tax Division, Department of Justice, were on brief ______
for appellee.

____________________

August 21, 1996
____________________
____________________

*Of the District of Massachusetts, sitting by designation.












CYR, Circuit Judge. Appellants Carlos J. and Jean M. CYR, Circuit Judge. _____________

Quijano, husband and wife, appeal from a district court order

rejecting their joint claim for a federal income tax refund

relating to the 1990 sale of their residence located in the

United Kingdom. We affirm the district court judgment.

I I

BACKGROUND BACKGROUND __________

Appellants, United States taxpayers, acquired their

residence for 297,500 pounds sterling on September 30, 1986. The

entire purchase price was financed through a mortgage loan in

pounds sterling. On October 12, 1988, it was increased to

330,000 pounds (exchange rate: $1.73 to 1 pound); on March 27,

1990, to 333,180 pounds (exchange rate $1.62 to 1 pound).

Ultimately, their capital improvements to the residence cost

45,647 pounds. No U.S. funds were used either to purchase or

improve the residence. On July 27, 1990, it was sold for 453,374

pounds, net of selling expenses, and the mortgage loan was

retired.

Appellants' 1990 joint federal income tax return

originally reported a $308,811 capital gain, utilizing the

exchange rate at date of purchase ($1.49 to 1 pound) to calculate

the adjusted cost basis, but using the exchange rate at date of

sale ($1.82 to 1 pound) to calculate the sale price. Appellants

later amended their 1990 return to claim a $30,610 refund arrived

at by utilizing the exchange rate at date of sale ($1.82 to 1

pound) to determine the adjusted cost basis as well as the sale


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price, thus resulting in a reduced $199,491 capital gain.

After the Internal Revenue Service disallowed their

amended refund claim, appellants initiated the present action.

The complaint alleged that Revenue Ruling 90-79 misinterprets our

decision in Willard Helburn, Ltd. v. Commissioner, 214 F.2d 815 ______________________ ____________

(1st Cir. 1954), and that the tax imposed violates the Sixteenth

Amendment, see Eisner v. Macomber, 252 U.S. 189 (1920). In due ___ ______ ________

course, appellants moved for summary judgment. The government

responded that the total cost basis of the residence must be

arrived at by utilizing the respective dollar-pound exchange

rates in effect when the residence was purchased and each

capital-improvement payment was made. The parties stipulated

that, thus calculated, appellants had overpaid $2,668, plus

related interest and penalties not presently relevant.

Ultimately, the district court entered judgment for appellants in

the amount of $2,668 plus interest and penalties as provided by

law. On appeal, appellants challenge the district court order

rejecting their motion for summary judgment in the larger amount

of $30,610.

II II

DISCUSSION1 DISCUSSION __________
____________________

1In a civil action for refund under 26 U.S.C. 7422(a),
"the taxpayer must bear the burden of proving that the challenged
IRS tax assessment was erroneous." Webb v. Internal Revenue ____ _________________
Service of the United States, 15 F.3d 203, 205 (1st Cir. 1994) _____________________________
(citing Lewis v. Reynolds, 284 U.S. 281, 283, 52 S. Ct. 145, 146, _____ ________
76 L.Ed 293, modified on other grounds, 284 U.S. 599, 52 S. Ct. ________ __ _____ _______
264, 76 L. Ed. 514 (1932)). We review the challenged summary
judgment ruling de novo. McCabe v. Life-Line Ambulance Serv., __ ____ ______ ___________________________
Inc., 77 F.3d 540, 544 (1st Cir. 1996), petition for cert. filed, ____ ________ ___ ____ _____

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____________________

64 U.S.L.W. 3808 (U.S. May 29, 1996) (No. 95-1929).

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A. Foreign Exchange Transactions A. Foreign Exchange Transactions _____________________________

We first consider the challenge to the tax refund

calculation arrived at by the district court under Revenue

Rulings 90-79 and 54-105. Section 1011 of the Internal Revenue

Code provides that the "adjusted basis for determining the gain .

. . from the sale or other disposition of property, whenever

acquired, shall be the basis (determined under section 1012 . .

.), adjusted as provided in section 1016." 26 U.S.C. 1011.

Under section 1012, generally the basis of property is its cost.

Id. 1012. For relevant purposes, section 1016(a)(1) states __

that a proper adjustment shall be made for "expenditures . . .,

or other items, properly chargeable to capital . . . ." Id. __

1016(a)(1).

Section 985(a) generally requires that all income tax

liability determinations are to be made in the "taxpayer's

functional currency," id. 985(a), which is the U.S. dollar for __

individual United States taxpayers, id. 985(b)(1)(A). With __

exceptions not relevant here, section 165(a) permits "a deduction

[for] any loss sustained during the taxable year . . . ." Id. __

165(a). Finally and importantly, in relevant part section 165(c)

limits the deductions available to individual United States

taxpayers to "(1) losses incurred in a trade or business [and]

(2) losses incurred in any transaction entered into for profit,

though not connected with a trade or business . . . ." Id. __

165(c).

1. Loss on Mortgage Loan Transaction 1. Loss on Mortgage Loan Transaction _________________________________


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The government essentially agrees that appellants

sustained a loss in their mortgage loan transaction, since the

value of the dollar declined, as against the pound sterling, from

the time of the mortgage loan to the date of its repayment.

Nonetheless, says the government, appellants may not offset their

mortgage-loan-transaction loss against their real-estate-

transaction gain, because "the borrowing and repayment of the

mortgage loan is a separate transaction from the purchase and

sale of the personal residence." Rev. Rul. 90-79, 1990-38 I.R.B.

26 (citing Willard Helburn, 214 F.2d at 818-19; Church's English _______________ ________________

Shoes, Ltd. v. Commissioner, 24 T.C. 56, 59 (1955), aff'd, 229 ___________ ____________ _____

F.2d 957 (2d Cir. 1956) (per curiam)). Moreover, since the

mortgage-loan-transaction loss was not "incurred in an activity

or as the result of an event described in section 165(c) of the

Code[,] . . . [it] may not [be] deduct[ed] . . . ." Id. __

Appellants concede that the mortgage loan transaction

was neither carried out by a trade or business nor entered into

for profit, but nonetheless urge an integrated transaction

approach so as to permit their $100,000 mortgage-loan-transaction

loss to be set off against the capital gain realized from the

sale of their residence. Appellants point out that though we

employed a separate transactions approach in Willard Helburn, 214 _______________

F.2d at 818, we recognized that an integrated approach to the

transaction might have been elected by the taxpayer.2
____________________

2Willard Helburn involved the tax treatment accorded a ________________
purchase of lambskins in New Zealand for inventory in the United
States, where both the purchase and the financing were in pounds

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Unfortunately for appellants, Congress has since foreclosed an

integrated transaction approach to the exclusively foreign-

currency financed acquisition involved in the present case.

Appellants urge, in effect, that their mortgage loan

transaction be considered part of a "hedging transaction" under

I.R.C. 988(d)(1), which might result in its integrated

treatment as part and parcel of their real estate transaction.

See 26 U.S.C. 988(d)(1). "To the extent provided in ___

regulations," id., borrowing under a debt instrument in which the ___

taxpayer is obligated to repay the loan in "a nonfunctional

currency," id. 988(c)(1), will qualify for treatment as part of ___

a "section 988 hedging transaction" provided the taxpayer (i)

entered into the transaction primarily "to reduce risk of

currency fluctuations with respect to property which is held or

to be held by the taxpayer," id. 988(d)(2)(A)(i), and (ii) ___ ___

identified the transaction as a section 988 hedging transaction.

Id. 988(d)(2)(B). ___

Even assuming their transaction qualified, however,
____________________

sterling. We noted that "[t]he purchases of the skins in New
Zealand and the various financial arrangements whereby [the
taxpayer] ultimately discharged in dollars its obligations
arising out of such purchases might be regarded as a single
integrated transaction." 214 F.2d at 818. But we also went on
to note that "[t]he purchases of the skins in New Zealand might
be viewed separately and distinct from the subsequent financial
arrangements . . . ." Id. Since the taxpayer rejected the __
integrated transaction approach, and the parties stipulated to
the tax treatment of the purchase, we treated the financing
separately from the purchase. Id. at 819. Finally, since the __
pound had dropped in relation to the dollar, we concluded that
the taxpayer had realized a taxable gain by settling the mortgage
loan with less costly pounds than the pounds originally borrowed.
Id. __

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appellants were ineligible for "hedging transaction" treatment

because it is conceded that their mortgage-loan-financing

transaction was neither conducted by a trade or business nor

entered into for profit. See id. 988(e). The Tax Reform Act of ___ __

1986 provided that the section 988 rules, and thus "hedging

transaction" treatment under section 988, "would be inapplicable

to foreign currency gain or loss recognized by a U.S. individual

residing outside of the United States upon repayment of a foreign

currency denominated mortgage on the individual's principal

residence. The principles of current law would continue to apply

to such transaction." H.R. Conf. Rep. No. 841, 99th Cong., 2d

Sess. II-669, reprinted in 1986 U.S.C.C.A.N. 4757. By reason of ____________

the interpretation adopted by Congress, moreover, "[e]xchange

gain or loss is separately accounted for, apart from gain or loss

attributable to the underlying transaction" under present law.

Id. at 4750. Thus, appellants' claim fails. __

2. Capital Gain on Real Estate Sale 2. Capital Gain on Real Estate Sale ________________________________

The government follows up with the contention that "the

cost and selling price of the [residence] should be expressed in

American currency at the rate of exchange prevailing as of the

date of the purchase and the date of the sale, respectively."

Rev. Rul. 54-105, 1954-1 C.B. 12; see Church's English Shoes, 229 ___ ______________________

F.2d at 958.3 Appellants agree that the 453,374 pounds received
____________________

3In Willard Helburn, the parties and the court, sub ________________ ___
silentio, analyzed the purchase and financing of the lambskins as ________
though the U.S. dollar were the taxpayer's functional currency.
The parties stipulated that the cost of the lambskins added to
the taxpayer's inventory was to be translated at the dollar-pound

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for their residence should be translated into U.S. dollars at the

$1.82 exchange rate prevailing at the date of sale. They argue,

however, that the 343,147 pound adjusted cost basis of the

residence, consisting of the 297,500 pound purchase price and the

45,647 pounds paid for capital improvements, likewise should be

expressed in U.S. dollar terms as of the date of the sale. ____

Appellants correctly state that, viewed "in the foreign currency

in which it was transacted," the purchase generated a 110,227

pound gain as of the date of the sale, which translates to

approximately $200,000 at the $1.82 per pound exchange rate.

Therefore, they say, the difference between the approximate

$300,000 gain under the government's computation, and the

$200,000 gain appellants suggest, approximates a $100,000

unrealized foreign exchange gain on the residence that resulted __________

from the increase in the dollar-pound exchange rate between the

dates the residence was bought and sold. However fair and

reasonable their argument may be, it amounts to an untenable

attempt to convert their "functional currency" from the U.S.

dollar to the pound sterling.

Under I.R.C. 985(b)(1), use of a functional currency

other than the U.S. dollar is restricted to qualified business

units ("QBU"s). The functional currency of a QBU that is not

required to use the dollar is "the currency of the economic

environment in which a significant part of such unit's activities
____________________

exchange rate prevailing at the date of their purchase, 214 F.2d
at 818, and their stipulation was accepted by the court, id. at __
819.

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are conducted and which is used by such unit in keeping its books

and records." 26 U.S.C. 985(b)(1)(B). Although appellants

correctly assert that their residence was purchased "for a pound-

denominated value" while they were "living and working in a

pound-denominated economy," under I.R.C. 989(a) a QBU must be a

"separate and clearly identified unit of trade or business of a

taxpayer which maintains separate books and records." 26 U.S.C.

989(a). And since appellants concede that the purchase and

sale of their residence was not carried out by a QBU, the

district court properly rejected their plea to treat the pound as

their functional currency.

B. The Sixteenth Amendment Claim B. The Sixteenth Amendment Claim _____________________________

Appellants launch a double-barreled claim that the

income taxation at issue in this case was imposed in violation of

the Sixteenth Amendment. The Sixteenth Amendment eliminated any

requirement that "income taxes" imposed by Congress be

apportioned among the states. See Eisner, 252 U.S. at 205.4 ___ ______

Since Eisner, the Supreme Court has described "`income' . . . in ______

its constitutional sense," as "instances of undeniable accessions

to wealth, clearly realized, and over which the taxpayers have

complete dominion." Commissioner v. Glenshaw Glass Co., 348 U.S. ____________ __________________

426, 432 n.11 (1955) (internal quotation marks omitted), id. at __

431. Their Sixteenth Amendment claim fails as well.

____________________

4"The Congress shall have power to lay and collect taxes on
incomes, from whatever source derived, without apportionment
among the several States, and without regard to any census of
enumeration." U.S. Const. amend. XVI.

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1. The Mortgage-Loan Transaction Loss 1. The Mortgage-Loan Transaction Loss __________________________________

With their initial volley, appellants implicitly

challenge the longstanding congressional power to determine

allowable deductions from gross income. Federal income tax

deductions are matters of legislative grace. Welch v. United _____ ______

States, 750 F.2d 1101, 1106 (1st Cir. 1985) (citing New Colonial ______ ____________

Ice. Co. v. Helvering, 292 U.S. 435, 440, 54 S. Ct. 788, 790, 78 ________ _________

L. Ed. 1348 (1934)). The nonintegrated tax treatment Congress

accords the acquisition, sale, and financing of appellants'

residence simply renders nondeductible the foreign exchange loss

on their foreign-currency denominated mortgage loan. As we have

made clear in the past, Congress possesses plenary power to

determine allowable deductions from the gross income it has

elected to tax. See State Mut. Life Assurance Co. of Worcester ___ ___________________________________________

v. Commissioner, 246 F.2d 319, 324 (1st Cir. 1957) (citing ____________

Helvering v. Independent Life Ins. Co., 292 U.S. 371, 381 _________ ____________________________

(1934)).

2. The Capital Gain on the Residence 2. The Capital Gain on the Residence _________________________________

Second, appellants argue that it would violate the

Sixteenth Amendment to tax, as income, any foreign-exchange

"gain" relating to the sale of their residence, since they

realized no "accession to wealth" as a result of the exchange ________ __

rate disparity which developed between the purchase and sale of

their residence. Their argument attempts to revive the

"functional currency" debate already discussed. See supra pps. ___ _____

7-9. As the government points out, to purchase property with a


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foreign currency necessarily places the individual United States

taxpayer "in a position to gain or lose from a change in the

exchange rate . . . ." Should the foreign currency increase in

value (as against the dollar) by the time the property is sold,

the resulting gain in U.S. dollars, the functional currency of

the individual United States taxpayer, plainly qualifies as

realized income, fully taxable under the Constitution.

III III

CONCLUSION CONCLUSION __________

Accordingly, the district court judgment is affirmed.

The parties shall bear their own costs.

SO ORDERED. SO ORDERED. __________






























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