T.C. Memo. 1999-162
UNITED STATES TAX COURT
JERRY MYERS JOHNSON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14639-97. Filed May 13, 1999.
Jerry Myers Johnson, pro se.
Wendy L. Wojewodzki, for respondent.
MEMORANDUM OPINION
FAY, Judge: Respondent determined a deficiency in
petitioner's 1994 Federal income tax of $32,794 and an accuracy-
related penalty under section 66621 in the amount of $6,559.
1
All section references are to the Internal Revenue Code in
effect for 1994, all Rule references are to the Tax Court Rules
(continued...)
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After concessions, the sole issue for decision is whether
petitioner must recognize discharge of indebtedness income
pursuant to section 61(a)(12). Petitioner bears the burden of
disproving respondent's determination on this issue. See Rule
142(a).
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
incorporated herein by this reference. Petitioner resided in
Shepherdstown, West Virginia, when he filed his petition. During
the year in issue, petitioner timely filed a separate Federal
income tax return.
The facts are undisputed. In 1990, petitioner and his
former wife, Norene, borrowed $130,612 from PNC Mortgage Corpora-
tion of America (PNC) to finance their purchase of a home in
Somerset, New Jersey. The Department of Veterans' Affairs
guaranteed the loan. In 1994, PNC foreclosed on the property
after petitioner and Norene (hereinafter sometimes referred to as
the borrowers) had defaulted on their payment obligations. The
property was sold for $93,251 by the county sheriff in July 1994.
At the time of the foreclosure, the borrowers owed PNC $160,014,
consisting of $129,292 mortgage principal, $23,489 accrued and
1
(...continued)
of Practice and Procedure, and all dollar amounts have been
rounded to the nearest dollar.
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unpaid interest, $3,672 in escrow fees, and $3,561 in liquidation
expenses. The parties have stipulated that, in March 1994, 4
months before the foreclosure sale, the property had a fair
market value of $105,000, and that, after the sale, PNC dis-
charged the balance due in the amount of $66,763. Petitioner was
not insolvent when the discharge occurred.
PNC issued petitioner a Form 1099-C (Cancellation of Debt),
reflecting that he had received $66,763 in discharge of indebted-
ness income during 1994. Petitioner did not report any of this
amount on his 1994 Federal income tax return. In the notice of
deficiency, respondent increased petitioner's income by $66,763.
Respondent now concedes that petitioner need report only the
amount by which the outstanding balance of the loan exceeds the
fair market value of the property. Respondent concedes further
that, under section 108(e)(2), petitioner is entitled to exclude
the accrued interest of $23,489 from the discharged indebtedness,
because payment of that liability would have given rise to a
deduction. Thus, according to respondent, the difference of
$55,014 (outstanding loan balance of $160,014, less the proper-
ty's fair market value of $105,000, as stipulated) represents
petitioner's discharge of indebtedness, of which only $31,525 is
taxable because of the accrued interest exclusion.
Petitioner admits to realizing discharge of indebtedness
income. He argues, however, that the full amount should be
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excluded from his gross income because the discharge occurred
when he was forced into early retirement by "city and state
government representatives [who] illegally and unjustly inter-
fered in * * * [his] career as a teacher".
Where a recourse mortgage has been discharged, cancellation
of indebtedness income arises to the extent the amount of the
debt exceeds the fair market value of the property. See Gehl v.
Commissioner, 102 T.C. 784, 786 (1994), affd. without published
opinion 50 F.3d 12 (8th Cir. 1995); Bialock v. Commissioner, 35
T.C. 649, 660 (1961); sec. 1.1001-2(c), Example (8), Income Tax
Regs. Based on all the surrounding facts and circumstances, a
debt is considered discharged the moment it becomes clear that it
will never be repaid. See Cozzi v. Commissioner, 88 T.C. 435,
445 (1987).
Respondent argues that, in 1994, when petitioner was dis-
charged from having to pay the balance due on foreclosure, he
realized cancellation of indebtedness income. Petitioner makes
no argument to the contrary. For example, he presents no
evidence suggesting that the unpaid recourse liability survives
as a legally enforceable obligation against him or, alterna-
tively, that he had no obligation to repay the loan initially
advanced by PNC. Moreover, petitioner does not dispute that, if
the indebtedness is found to be taxable, the amount includable is
$31,525, the difference between the outstanding loan and the
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property's fair market value, or $55,014, less the forgiven
interest of $23,489.
Generally, a taxpayer must include in gross income a dis-
charge of indebtedness. See sec. 61(a)(12); sec. 1.61-12(a),
Income Tax Regs. The rationale for this principle is that, when
a debt is forgiven, formerly encumbered assets of the borrower
become freely available for his use and enjoyment. Since the
loan does not have to be repaid, the newly freed assets con-
stitute income.
There are, however, exceptions to this general rule.
Section 108(a) provides that a taxpayer may exclude from gross
income the discharge of indebtedness if the discharge occurs in a
bankruptcy case, or, alternatively, when the taxpayer is insol-
vent, or if the indebtedness is qualified farm or business real
estate debt. Petitioner concedes that he was not insolvent
within the meaning of section 108. Moreover, nothing in the
record suggests that the other circumstances described above
exist here. Similarly, there is no indication that PNC intended
to make a gift to petitioner. See Commissioner v. Jacobson, 336
U.S. 28, 51 (1949) (a gratuitous forgiveness of debt is a gift,
resulting in no income to the debtor); Helvering v. American
Dental Co., 318 U.S. 322 (1943).
Rather than dispute the facts in this case, petitioner
argues that he is entitled to exclude the full amount of
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discharged indebtedness, because he had no control over the
series of incidents that culminated in the discharge. To the
extent we understand petitioner's argument, it proceeds as
follows. He claims that, in 1994, he was forced to retire early
from his profession as a teacher and that, as a result of the
financial difficulties he encountered because of a reduced
pension, he defaulted on his payment obligations. According to
petitioner, the financial difficulties which ensued after his
retirement were a direct consequence of his arrest nearly 20
years earlier by two police officers who also served on the local
board of education——an arrest he calls unlawful and in violation
of his constitutional rights. Thus, in petitioner's view, the
improper actions by local authorities had caused him to realize
discharge of indebtedness income.
While we do not question the sincerity with which petitioner
asserts this view, there is no merit to his argument. Congress
did not create an exception to alleviate the kind of hardship
that petitioner describes, and we must apply the law as written.
Accordingly, under section 61(a)(12), petitioner must include the
$31,525 discharge of indebtedness in gross income.
To reflect the foregoing and concessions by the parties,
Decision will be entered under
Rule 155.