T.C. Memo. 2005-283
UNITED STATES TAX COURT
TIMOTHY J. COBURN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6695-04. Filed December 6, 2005.
Richard A. Seigal and Mark S. Gregory, for petitioner.
Michael J. Proto, for respondent.
MEMORANDUM OPINION
WELLS, Judge: Respondent determined a deficiency in
petitioner’s 2000 Federal income tax of $277,951 and a section
6662 accuracy-related penalty of $55,590.20. The issue to be
decided is whether petitioner must recognize discharge of
indebtedness income in 2000 with respect to a loan on which
petitioner defaulted. Unless otherwise indicated, all section
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references are to the Internal Revenue Code, as amended, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
Background
The parties submitted the instant case fully stipulated,
without trial, pursuant to Rule 122. The parties’ stipulations
of fact are hereby incorporated by reference and are found as
facts in the instant case. At the time of filing the petition,
petitioner resided in Glastonbury, Connecticut.
During 1996, petitioner received stock of PhyMatrix
Corporation (PhyMatrix) and CareMatrix Corporation (CareMatrix)
which had an aggregate value of $1,675,000 at the time of
receipt.1 Petitioner incurred a Federal income tax liability of
$621,980 related to the receipt of the stock.2 Petitioner
borrowed from CareMatrix an amount equal to the Federal income
tax liability (the loan), pledging 57,248 shares of PhyMatrix
common stock (the collateral) as security for the loan. The loan
and the pledge of the collateral are hereinafter collectively
referred to as the loan transaction.
1
The record does not reveal the separate amount or value of
the CareMatrix stock or the value of the PhyMatrix stock at the
time of receipt by petitioner.
2
Petitioner appears to have taken an aggregate basis in the
stock of both CareMatrix and PhyMatrix equal to the aggregate
$1,675,000 value of these stocks at the time of receipt.
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On April 15, 1997, to complete the loan transaction,
petitioner executed the following three documents: (1) A
promissory note (the promissory note), (2) a stock pledge
agreement (the stock pledge agreement), and (3) a stock transfer
power (the stock transfer power). The promissory note, stock
pledge agreement, and stock transfer power are sometimes
hereinafter referred to as the loan documents. The promissory
note provided that the principal and interest were due and
payable on the earlier of either April 15, 2000, or the date of
the registration of any shares of PhyMatrix stock received by
petitioner pursuant to an agreement dated May 3, 1996. The
promissory note further provided that petitioner would secure the
liability underlying the promissory note with the collateral.
The stock pledge agreement also provided that petitioner was
required to pledge the collateral as security for the liability
underlying the promissory note and set forth the rights and
duties of petitioner and CareMatrix with respect to the
collateral. The stock transfer power provided that petitioner
sold, assigned, and transferred the collateral for value
received. At all relevant times, Abraham D. Gosman (Mr. Gosman)
served as Chief Executive Officer and Chairman of the Board of
CareMatrix and was responsible for the terms of the loan
documents.
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As of April 15, 1997, the collateral had an aggregate market
value of approximately $750,000, which represented 120 percent of
the outstanding principal due on the promissory note.3 At the
request of CareMatrix, petitioner delivered the loan documents to
CareMatrix’s counsel. On or about May 29, 1997, CareMatrix took
possession of the loan documents and the stock certificate for
the collateral from its counsel.
The promissory note became due and payable on April 15,
2000, at which time the outstanding principal and interest due
was $746,376.52. CareMatrix subsequently demanded payment, but
petitioner refused to pay, alleging that the promissory note was
nonrecourse and that CareMatrix held the collateral. CareMatrix
made no further collection efforts.
3
The parties stipulated the following with respect to the
value of the collateral as of Apr. 15, 1997: “Pursuant to the
Note, the shares pledged had an aggregate market value of 120% of
the principal borrowed - approximately $750,000.00.” As noted
above, petitioner appears to have taken a basis in the CareMatrix
and PhyMatrix stock equal to the value of the PhyMatrix and
CareMatrix stock at the time the stock was received by petitioner
during 1996. However, the record provides no evidence that the
value of the PhyMatrix stock was the same on April 15, 1997 (the
date of the loan transaction) as it was on the date that the
stock was transferred to petitioner during 1996. Because the
value of the collateral may have fluctuated from the date that
petitioner received the PhyMatrix stock until the date that
petitioner pledged the PhyMatrix stock as collateral, the
aforementioned stipulation as to the value of collateral on
Apr. 15, 1997, is insufficient to establish petitioner’s basis
in the collateral on that date. Consequently, we are unable to
determine from the record petitioner’s basis in the collateral.
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On July 14, 2000, PhyMatrix filed a bankruptcy plan of
reorganization, which became effective on September 21, 2000.
The plan provided for the conversion of PhyMatrix stock to shares
of the newly reorganized entity. However, the plan required that
any PhyMatrix shares be tendered for conversion by March 20,
2001. The collateral was not timely tendered for conversion.4
Respondent determined that petitioner’s default on the
promissory note resulted in cancellation of indebtedness income
in the amount of $750,000 and that petitioner should be subject
to an accuracy-related penalty of $55,590.20.
Discussion
Section 61(a)(12) provides that gross income includes income
from discharge of indebtedness, which generally equals the amount
due on the obligation less the amount of any consideration paid
for the discharge. Babin v. Commissioner, 23 F.3d 1032, 1034
(6th Cir. 1994), affg. T.C. Memo. 1992-673. Section 61(a)(3)
provides that gross income includes gains derived from dealings
in property. Section 1001(a) provides that gain from the sale or
other disposition of property is the excess of the amount
realized over the property’s adjusted basis and that loss from
the sale or other disposition of property is the excess of the
4
We note that sec. 4 of the Stock Pledge Agreement appears
to require petitioner to tender the collateral for conversion,
pledge shares of the newly reorganized entity as security on the
loan, and deliver such pledged shares to CareMatrix.
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property’s adjusted basis over the amount realized. Relying on
Cozzi v. Commissioner, 88 T.C. 435 (1987),5 respondent contends
that petitioner’s default on the loan results in discharge of
indebtedness income to petitioner pursuant to section 61(a)(12).
Petitioner contends that the loan default is treated as a sale or
other disposition of the collateral pursuant to sections 61(a)(3)
and 1001(a), rather than a discharge of indebtedness.
The facts and circumstances of the instant case demonstrate
that petitioner abandoned the collateral in 2000.6 CareMatrix
took possession of the loan documents and the stock certificate
during the loan transaction. CareMatrix demanded payment from
petitioner in 2000, but petitioner refused to pay on grounds that
5
Respondent also cites Carlins v. Commissioner, T.C. Memo.
1988-79, which relied on our holding in Cozzi v. Commissioner, 88
T.C. 435 (1987).
6
We apply a facts and circumstances analysis to determine if
or when an abandonment occurred. Cozzi v. Commissioner, supra at
446. “The proper test is whether, under the facts and
circumstances, it is clear for all practical purposes that the
taxpayer will not retain the property; an overt act of
abandonment by the taxpayer is not necessary.” L&C Springs
Associates v. Commissioner, 188 F.3d 866, 868 (7th Cir. 1999),
affg. T.C. Memo. 1997-469.
In 2925 Briarpark v. Commissioner, 163 F.3d 313, 318 (5th
Cir. 1999), affg. T.C. Memo. 1997-298, the Court of Appeals for
the Fifth Circuit stated that sec. 61(a)(3) applies if (1) the
debtor is relieved of the obligation to repay the debt and (2)
the debtor is relieved of title to the collateral. However, the
court did not hold that sec. 61(a)(3) cannot apply in absence of
a formal transfer of title. Consequently, the formal passage of
legal title does not necessarily establish the time of
abandonment. L&C Springs Associates v. Commissioner, supra at
870.
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the loan was nonrecourse and that CareMatrix held the collateral.
CareMatrix took no further action to collect the outstanding
principal and interest on the loan from petitioner. In an
affidavit stipulated by the parties, Mr. Gosman stated that
petitioner and CareMatrix “intended that, in the event of a
default, repayment would be made only from the collateral and no
other source.” Consequently, we conclude that petitioner
abandoned the collateral upon his default. Accordingly, we
consider the Federal income tax consequences of petitioner’s
default on the loan and abandonment of the collateral.
The parties in the instant case dispute whether the loan is
recourse or nonrecourse.7 The regulations under section 1001
distinguish between a debtor’s disposition of collateral in
satisfaction of an underlying nonrecourse liability and a
debtor’s disposition of collateral in satisfaction of an
underlying recourse liability.8 Specifically, section 1.1001-
2(a), Income Tax Regs.,9 provides that the amount realized on the
7
Respondent concedes that the loan constitutes bona fide
indebtedness.
8
Such a distinction may affect the character of any gain or
loss on the transaction and the availability of certain
exclusions from gross income. See secs. 1221, 108.
9
Sec. 1.1001-2, Income Tax Regs. Discharge of liabilities.--
(a) Inclusion in amount realized. (1) In general.--
Except as provided in paragraph (a)(2) and (3) of this
section, the amount realized from a sale or other
(continued...)
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sale or other disposition of property generally includes the
amount of liabilities from which the debtor is discharged but
that the amount realized on the disposition of property securing
a recourse liability does not include discharge of indebtedness
income. Consequently, a debtor’s transfer, or abandonment, of
property to a creditor in satisfaction of a nonrecourse liability
is treated as a sale or other disposition of the property, and
any resulting income constitutes gain on the disposition of
property rather than discharge of indebtedness income.10 L&C
Springs Associates v. Commissioner, 188 F.3d 866, 868 (7th Cir.
1999), affg. T.C. Memo. 1997-469. In contrast, a debtor’s
transfer of property to a creditor in satisfaction of a recourse
liability results in gain from the sale or other disposition of
property to the extent that the fair market value of the property
9
(...continued)
disposition of property includes the amount of
liabilities from which the transferor is discharged as a
result of the sale or disposition.
(2) Discharge of indebtedness.--The amount realized
on a sale or other disposition of property that secures
a recourse liability does not include amounts that are
(or would be if realized and recognized) income from the
discharge of indebtedness under section 61(a)(12). * *
*
10
If the amount of the nonrecourse liability exceeds the
value of the property at the time of the transfer, the debtor
realizes gain to the extent that the liability exceeds the
debtor’s basis in the property at the time of transfer.
Commissioner v. Tufts, 461 U.S. 300, 313 (1983).
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exceeds its basis and, to the extent that the liability exceeds
the property’s fair market value, discharge of indebtedness
income is realized. Frazier v. Commissioner, 111 T.C. 243, 245
(1998); sec. 1.1001-2(c), Income Tax Regs.
In the instant case, petitioner contends that the loan is
nonrecourse. As to the recourse nature of the loan, respondent
is not of one mind. Respondent’s trial memorandum refers to the
liability on the loan as nonrecourse. Respondent’s opening brief
contends that the Federal income tax result in the instant case
does not depend on whether the loan is recourse or nonrecourse.
Respondent’s reply brief, however, contends that the loan is
recourse. For the reasons discussed below, we conclude that
petitioner’s abandonment of the collateral did not result in
discharge of indebtedness income to petitioner during
petitioner’s taxable year 2000, regardless of whether the
liability underlying the promissory note is recourse or
nonrecourse.11
As stated above, a debtor’s abandonment of collateral in
satisfaction of a nonrecourse liability is treated for Federal
income tax purposes as a sale of the collateral pursuant to
section 1001(a). L&C Springs Associates v. Commissioner, supra
at 868. Consequently, in the instant case, assuming that the
11
Consequently, we need not decide whether the loan is
recourse or nonrecourse.
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loan is nonrecourse, we conclude that any income realized by
petitioner on the abandonment of the collateral in satisfaction
of the loan is properly treated for Federal income tax purposes
as a gain on the sale or other disposition of the collateral
rather than discharge of indebtedness income. Id.; see sec.
1.1001-2(a)(1), Income Tax Regs. Accordingly, we would hold that
petitioner realized no discharge of indebtedness income in 2000
were we to assume that the underlying liability is nonrecourse.
As noted above, respondent’s trial memorandum and opening
brief contend that the default resulted in discharge of
indebtedness income to petitioner in 2000. Respondent’s reply
brief surprisingly contends, for the first time, that petitioner
is alternatively liable for gain in the amount of $750,000,
representing an amount realized of $750,000 and a basis of zero.
However, respondent does not offer any evidence to support
respondent’s contention of a zero basis, and the record contains
no such evidence. Under such circumstances, respondent is
prohibited from raising such an issue for the first time on
brief. See Smalley v. Commissioner, 116 T.C. 450, 456 (2001).
Petitioner would be prejudiced were we to consider such an issue.
Indeed, we note that respondent objected to petitioner’s motion
for leave to supplement the evidentiary record with evidence of
the value and basis of the collateral, filed after respondent’s
new argument in respondent’s reply brief, which motion we denied.
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Petitioner obviously was surprised by respondent’s raising of a
new issue on brief that required additional evidence to decide.
Moreover, we find respondent’s reliance on Cozzi v.
Commissioner, 88 T.C. 435 (1987), to be misplaced. In Cozzi, the
Commissioner contended that the taxpayers realized discharge of
indebtedness income upon their abandonment of worthless
collateral securing a nonrecourse liability. The taxpayers in
Cozzi contended that they did not realize discharge of
indebtedness income because they did not abandon the collateral
during the year in issue.12 Id. at 446. We held that the facts
and circumstances evidenced an abandonment of worthless
collateral by the taxpayers during the year in issue and that
such an abandonment of worthless collateral securing a
nonrecourse liability established a discharge of the underlying
liability. Id. at 445-448. Cozzi did not involve a dispute of
whether a debtor’s abandonment of collateral should be treated
for Federal income tax purposes as generating income from a sale
or from a discharge of the underlying nonrecourse liability.
We now turn to an analysis of the Federal income tax
treatment of the loan default and abandonment of the collateral
based upon the assumption that the loan was recourse. In
contrast to a nonrecourse liability, a debtor’s abandonment of
12
The taxpayers in Cozzi appear to have conceded that
discharge of indebtedness income would result from an abandonment
of the collateral.
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collateral securing a recourse liability upon the debtor’s
default on the liability, alone, does not extinguish the
underlying liability. Lockwood v. Commissioner, 94 T.C. 252, 260
(1990). Unlike collateral securing a nonrecourse liability, the
collateral securing a recourse liability does not represent the
only source of repayment.13 In the instant case, the loan
documents provide CareMatrix with the right to enforce
petitioner’s repayment of the loan, irrespective of whether
petitioner abandoned the collateral to CareMatrix.14
13
Black’s Law Dictionary 1086 (7th ed. 1999) provides the
following definitions of a recourse note and a nonrecourse note:
recourse note. A note that may be satisfied upon
default by pursuing the debtor’s other assets in
addition to the collateral securing the note. Cf.
nonrecourse note.
nonrecourse note. A note that may be satisfied upon
default only by means of the collateral securing the
note, not by the debtor’s other assets. Cf. recourse
note.
14
We recognize, and petitioner does not dispute, that the
terms of the loan documents on their face provide for a recourse
liability. Petitioner instead contends that the loan is
nonrecourse based upon two alternative contentions. The first
contention is that the substance rather than the form of the
transaction should govern and that the underlying facts and
circumstances support the conclusion that the loan is
nonrecourse. Alternatively, petitioner contends that the parties
intended for the loan to be nonrecourse, that the parties made a
mutual mistake in executing a promissory note that did not
accurately reflect their intent, and that the terms of the loan
documents should be reformed to accurately reflect such intent.
Petitioner contends that petitioner “transferred” the collateral
to CareMatrix in satisfaction of a nonrecourse liability, that
the “transfer” of the collateral is properly treated as the sale
(continued...)
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Specifically, the promissory note provides that a release of the
collateral by petitioner does not satisfy petitioner’s
obligation.
[The petitioner’s liability] hereunder * * * shall
remain unimpaired, notwithstanding * * * the release
* * * of all or any part of security * * *.
The promissory note also does not waive the right of CareMatrix
to pursue legal remedies upon nonpayment.
[CareMatrix] shall not, by any act, delay, omission or
otherwise be deemed to waive any of its rights or
remedies hereunder unless such waiver be in writing and
signed by [CareMatrix], and then only to the extent
expressly set forth therein.
The stock pledge agreement provides that the pledge is to remain
in effect until the loan is paid in full, at which time
CareMatrix is to return the collateral to petitioner.
Termination of Pledge. This Pledge shall remain
in effect until all terms and conditions of the Note
have been satisfied in full and the Indebtedness has
been paid in full whereupon the Lender shall forthwith
assign, transfer and deliver to [petitioner] without
representation, warranty or recourse, against the
appropriate receipts, all the Pledged Shares, if any,
then held by it in pledge hereunder.
Additionally, the period of limitations for CareMatrix to
commence an action to enforce petitioner’s repayment does not
expire until April 15, 2006. See Mass. Gen. Laws ch. 106,
14
(...continued)
of the collateral during petitioner’s taxable year 2000, and that
such a sale does not result in discharge of indebtedness income.
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§ 3-118 (1998 & Supp. 2005).15 The foregoing demonstrates that
petitioner’s abandonment of the collateral, assuming the loan was
recourse, did not discharge petitioner from the loan during
petitioner’s taxable year 2000. CareMatrix would have until at
least April 15, 2006, to enforce payment on the loan if it is
recourse. A taxpayer must recognize income from the discharge of
indebtedness where (1) a liability exists at the time of the
alleged discharge and (2) the taxpayer was in fact discharged
from such liability. Babin v. Commissioner, 23 F.3d at 1034;
Waterhouse v. Commissioner, T.C. Memo. 1994-467. In the instant
case, the loan default does not result in discharge of
indebtedness income, assuming the loan was recourse, because
petitioner was never discharged from liability on the loan.
Accordingly, we hold that petitioner realized no discharge of
indebtedness income with respect to the loan for petitioner’s
taxable year 2000.
15
In the instant case, the promissory note provides: “This
Note shall be governed by and construed in accordance with the
laws of the Commonwealth of Massachusetts, to the maximum extent
the parties may so lawfully agree.” Similarly, the stock pledge
agreement provides: “This Agreement shall in all respects be
construed and interpreted in accordance with and governed by the
laws of the Commonwealth of Massachusetts.” Consequently, the
laws of Massachusetts govern the interests and rights of the
parties with respect to these documents. See Cook v.
Commissioner, 80 T.C. 512, 520 (1983). Mass. Gen. Laws ch. 106,
sec. 3-118 (2005), provides that an action to enforce payment of
a note must be commenced within 6 years after the due date stated
in the note. As noted above, the promissory note provided for a
due date of Apr. 15, 2000.
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On the basis of the foregoing, we hold that petitioner did
not realize discharge of indebtedness income with respect to the
loan default and abandonment of the collateral and that
petitioner is not liable for a section 6662 accuracy-related
penalty. We have considered all contentions that the parties
have raised. To the extent not addressed herein, those
contentions are without merit or unnecessary to reach.
To reflect the foregoing,
Decision will be entered for
petitioner.