Preslar v. Commissioner

T.C. Memo. 1996-543

UNITED STATES TAX COURT

LAYNE E. PRESLAR AND SUE F. PRESLAR, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14051-94. Filed December 17, 1996.

Ron Lewis, for petitioners.

Pamelya P. Herndon, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Respondent determined a deficiency in

petitioners' 1989 joint Federal income tax of $123,028 and an

addition to tax under section 6651(a)(1) of $6,151.
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Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for 1989, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

After concessions by petitioners, the primary issue for

decision is whether petitioners received discharge of

indebtedness income upon settlement of their liability on a bank

loan.

FINDINGS OF FACT

Many of the facts have been stipulated and are so found.

At the time the petition was filed, petitioners resided in

Cloudcroft, New Mexico. All references to petitioner are to

Layne E. Preslar.

In early 1983, petitioner, a real estate agent of 25 years,

began negotiations for the purchase of a 2,500-acre ranch near

Cloudcroft, New Mexico, known as the McCracken-Rinconada Ranch

(the Ranch). Petitioner wanted to develop the Ranch as a

sportsmen's resort. Petitioner planned to subdivide and develop

160 acres of the Ranch and to sell 1- to 2-acre lots on which

cabins or vacation homes could be built (cabin lots). Each cabin

lot would be sold for approximately $16,500, and petitioner

projected gross revenue from sales of cabin lots of approximately

$1,584,000. The remaining 2,340 acres on the Ranch that were not

to be sold as cabin lots would be used for hunting and other

outdoor recreation.
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After initial contact with owners of the Ranch regarding its

possible purchase, petitioner, at the owners' request, conducted

all discussions regarding purchase of the Ranch with a

representative of First City National Bank of Hobbs, New Mexico

(later known and hereinafter referred to as Moncor Bank). Moncor

Bank held a perfected security interest in the Ranch as a result

of a loan made to the owners of the Ranch. Moncor Bank's

security interest, however, was subordinate to those of two other

banks which also had made loans to the owners of the Ranch and

which had perfected security interests in the Ranch as collateral

for their loans. The owners of the Ranch had filed petitions in

the U.S. Bankruptcy Court for the District of New Mexico under

chapter 11, and Moncor Bank, as a secured creditor, was assisting

the owners in selling the Ranch in lieu of foreclosure.

On September 1, 1983, after 6 months of negotiations with

representatives of Moncor Bank, petitioners agreed to purchase

the Ranch for a stated purchase price of $1 million, to be

financed 100 percent by a loan from Moncor Bank (Bank loan).

Petitioners executed in favor of Moncor Bank a promissory note

with a stated total principal amount of $1 million, nominally

payable in 14 annual installments, with interest at 12 percent

per annum, and a final payment stated to be due on September 1,

1998.

On September 1, 1983, Moncor Bank paid $760,000 of the

stated $1 million loan proceeds to the two other banks which held
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security interests in the Ranch. Moncor Bank did not pay to

petitioners, nor to the former owners, the $240,000 balance of

the Bank loan. Rather, the $240,000 balance of the Bank loan was

reflected on Moncor Bank's records as a substitution of

petitioners' stated debt to Moncor Bank for the debt of the

former owners of the Ranch to Moncor Bank.

Moncor Bank agreed to allow petitioners to repay the

$1 million stated principal amount of the Bank loan through

petitioners' transfer or assignment to Moncor Bank of the written

installment contracts entered into by purchasers of the cabin

lots. Upon each cabin lot sale, the written contract for sale of

the lot would be assigned and physically transferred by

petitioners to Moncor Bank, and petitioners' stated principal

debt obligation to Moncor Bank on the Bank loan would be credited

with an amount equal to 95 percent of the stated contract price

regardless of actual payments received or to be received by

Moncor Bank from purchasers of the cabin lots. Upon each sale of

a cabin lot, Moncor Bank received a security interest in each

cabin lot in the event the purchaser defaulted on the installment

payment obligations agreed to in the purchase of the cabin lot.

Between September 1, 1983, and August 30, 1985, petitioner

sold 19 cabin lots and assigned all of the cabin lot sales

contracts to Moncor Bank. Moncor Bank credited 95 percent of the

total stated contract price reflected on the cabin lot sales

contracts that were assigned to it against the $1 million stated
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principal amount of the Bank loan petitioners owed to Moncor

Bank. Moncor Bank apparently received a total of $200,537 in

installment payments from purchasers of cabin lots.

On August 30, 1985, the U.S. Comptroller of the Currency

declared Moncor Bank insolvent, and the Federal Deposit Insurance

Corporation (FDIC) became the receiver of Moncor Bank. By letter

dated September 2, 1985, the FDIC informed petitioners of Moncor

Bank's insolvency and advised petitioners to make payments on the

Bank loan to the FDIC as receiver of Moncor Bank.

The FDIC refused to accept any further assignment from

petitioners of cabin lot sales contracts as repayment on the Bank

loan and ordered petitioners to suspend sales of cabin lots.

Petitioners complied with the FDIC's suspension order and did not

sell any more cabin lots, but petitioners did not make any

subsequent payments on the Bank loan.

In September of 1985, petitioners filed a lawsuit against

the FDIC for breach of contract, contesting their liability to

the FDIC for the $799,463 principal amount allegedly due on the

Bank loan ($1 million less $200,537 in actual payments received

by Moncor Bank equals $799,463) and seeking to require the FDIC

to accept assignment of cabin lot installment sales contracts as

payment on the Bank loan pursuant to petitioners' agreement with

Moncor Bank.

On December 19, 1988, petitioners and the FDIC settled their

dispute over petitioners' remaining liability on the Bank loan
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for $350,000. Petitioners borrowed this $350,000 from First

National Bank of Alamogordo in Alamogordo, New Mexico, and paid

the $350,000 to the FDIC. As a result of the settlement between

petitioners and the FDIC, a total of $550,537 was actually paid

on the Bank loan (petitioners' $350,000 settlement payment to the

FDIC plus the $200,537 in installment payments received by Moncor

Bank equals $550,537).

Petitioners' accountant prepared petitioners' 1989 joint

Federal income tax return. With their 1989 tax return,

petitioners filed a Form 4868 requesting an automatic extension

of time to file their 1989 tax return until August 15, 1990. On

August 20, 1990, respondent received petitioners' 1989 joint

Federal income tax return and their Form 4868.

On their 1989 tax return, petitioners did not include as

discharge of indebtedness income the $449,463 unpaid portion of

the stated principal amount of the Bank loan ($1 million stated

principal amount of the Bank loan less $550,537 paid on the loan

equals $449,463). Instead, petitioners filed with their 1989 tax

return a form electing under section 108(e)(5) to reduce their

tax basis in the Ranch by $430,000.1

On audit, respondent charged petitioners with $449,463 in

discharge of indebtedness income relating to the settlement

between the FDIC and petitioners of their indebtedness on the

1
The $430,000 represents petitioners' calculation of the
basis adjustment to be made under sec. 108(e)(5).
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Bank loan, effectively reversing their $430,000 reduction in

their tax basis in the Ranch. Respondent also determined an

addition to tax under section 6651(a)(1) for petitioners' failure

to timely file their 1989 joint Federal income tax return.

OPINION

Discharge of Indebtedness Income

Taxpayers generally are required to include cancellation or

discharge of indebtedness income in income. Sec. 61(a)(12). The

discharge, however, of a liability that is indefinite or

contingent will not trigger discharge of indebtedness income.

Colonial Sav. Association v. Commissioner, 85 T.C. 855, 862

(1985), affd. 854 F.2d 1001 (7th Cir. 1988). Also, where the

nature and amount of a liability are contested in a good faith

dispute and where a compromise settlement is reached, the excess

of the stated principal amount of the alleged debt over the

amount for which the liability is settled will not be treated as

discharge of indebtedness income. United States v. Hall, 307

F.2d 238 (10th Cir. 1962); N. Sobel, Inc. v. Commissioner, 40

B.T.A. 1263, 1265 (1939); 2 Mertens, Law of Federal Income

Taxation, sec. 11.19 (1996).

Petitioners argue that the economic realities of the

transaction before us reflect that the $1 million stated purchase

price for the Ranch was inflated, that it did not accurately

reflect the fair market value of the Ranch, and effectively that
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because of the unusual payment arrangement with Moncor Bank

relating to petitioners' assignment of the installment contracts,

petitioners should not be considered liable for the total

$1 million stated principal amount of the Bank loan.

Respondent argues that the fair market value of the Ranch

was $1 million, that petitioners were liable for the entire

$1 million stated principal amount of the Bank loan, and that the

payment arrangement between petitioners and Moncor Bank should

not be regarded as limiting petitioners' liability for the full

$1 million stated principal amount of the Bank loan. Respondent

therefore argues that no exception applies to preclude

petitioners' recognition of discharge of indebtedness income.

In the instant case, the unusual payment arrangement between

petitioners and Moncor Bank relating to the Bank loan casts

significant doubt on petitioners' liability for the total

$1 million stated principal amount of the Bank loan.

With every sale of a cabin lot, petitioners and Moncor Bank

reduced the stated principal amount due on the Bank loan by an

amount equal to 95 percent of the cabin lot sales contract,

regardless of the receipt by Moncor Bank of any actual

installment payments from purchasers of the cabin lots.

When the FDIC refused to honor this payment arrangement with

regard to the Bank loan, a legitimate dispute arose regarding the

nature and amount of petitioners' liability on the Bank loan.

The dispute over petitioners' liability on the Bank loan was
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settled in 1988, when the FDIC accepted a $350,000 payment in

complete satisfaction of petitioners' liability. Only at the

time of that settlement was the amount of petitioners' liability

on the Bank loan finally established.

For the above reasons, we conclude that petitioners'

liability on the promissory note to Moncor Bank was sufficiently

indefinite in nature and amount to avoid triggering any discharge

of indebtedness income when the settlement with the FDIC was

reached. Only at the time of the settlement did petitioners'

liability on the Bank loan become fixed and definite and equal to

the $550,537 figure agreed to by petitioners and the FDIC. We

conclude that petitioners are not to be treated as having

realized the discharge of indebtedness income in dispute herein.

Section 6651(a)(1) Addition to Tax

Section 6651(a)(1) imposes an addition to tax for the

failure to timely file a Federal income tax return. If a

taxpayer can show that the failure to timely file is due to

reasonable cause and not to willful neglect, the addition to tax

will not be imposed. Sec. 6651(a)(1). The burden of proving

that their income tax return was timely filed is on petitioners.

Rule 142; Welch v. Helvering, 290 U.S. 111, 115 (1933).

To be effective, requests for automatic extensions to file

Federal income tax returns must be filed on or before the date

prescribed for filing the returns. Raskin v. Commissioner, T.C.
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Memo. 1981-153, affd. 685 F.2d 436 (8th Cir. 1982); sec. 1.6081-

4(a)(3), Income Tax Regs.

Petitioners contend: (1) That because they filed a Form

4868, their 1989 tax return was not due until August 15, 1990;

and (2) that the complicated nature of their 1989 tax return

qualifies as reasonable cause for failure to timely file.

Because respondent did not receive petitioners' Form 4868

until August 20, 1990, the automatic extension that petitioners

sought was not triggered, and petitioners' 1989 tax return was

due to be filed on April 15, 1990.

Further, petitioners have not established reasonable cause

for failure to timely file their 1989 Federal income tax return.

The mere fact that preparation of their 1989 return was

complicated and that additional time was required to work on the

return does not establish reasonable cause for petitioners' late

filing.

To reflect the foregoing,

Decision will be entered

under Rule 155.