T.C. Summary Opinion 2007-214
UNITED STATES TAX COURT
KEVIN AND DEBORAH KEITH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5757-05S. Filed December 26, 2007.
Stephen G. Bresset, for petitioner.
Kristina L. Rico, for respondent.
CARLUZZO, Special Trial Judge: This case was heard
pursuant to the provisions of section 7463.1 Pursuant to section
7463(b), the decision to be entered is not reviewable by any
1
Unless otherwise indicated, section references are to
the Internal Revenue Code of 1986, as amended, in effect for
the relevant period. Rule references are to the Tax Court
Rules of Practice and Procedure.
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other court, and this opinion shall not be cited as precedent for
any other case.
Respondent determined a $12,448 deficiency in petitioners’
2002 Federal income tax and imposed a $2,490 section 6662(a)
accuracy-related penalty. The issues for decision are: (1)
Whether petitioners realized cancellation of indebtedness income
as a result of a foreclosure proceeding involving their
residence; and, if so (2) whether the underpayment of tax
required to be shown on petitioners’ 2002 Federal income tax
return is a substantial understatement of income tax.
Background
Some of the facts have been stipulated and are so found.
Petitioners are married to each other. Their joint 2002 Federal
income tax return was timely filed. At the time the petition was
filed, they resided in Pennsylvania.
In 1994, petitioners purchased a parcel of land in
Tobyhanna, Pennsylvania, for the purpose of constructing a house
to be used as the family residence (the property). Petitioners
financed the purchase of the land and/or the construction of the
house through a $118,825 loan (the loan) from America’s Wholesale
Lender, now know as Countrywide Home Loans, Inc. (Countrywide).
The loan was evidenced by a note and secured by a mortgage on the
property, each dated September 2, 1994.
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Petitioners apparently defaulted on their obligation to
repay the loan according to the terms of the note. As a result,
on December 13, 2000, foreclosure proceedings were initiated by
Countrywide, and on August 29, 2002, the property was seized from
petitioners pursuant to a writ of execution. On November 26,
2002, the property was sold for $80,500 to third-parties.
At the time the foreclosure proceeding was initiated, the
principal balance on the loan was $112,035. In accordance with
Pennsylvania procedures in such matters, for purposes of the
foreclosure proceeding, the property was valued pursuant to a
Broker’s Price Opinion in a range from $90,000 to $100,000
depending upon the “marketing time”.2
Countrywide’s recovery on the note as a result of the
foreclosure proceeding is not known. To the extent that it
received less than petitioners owed, the company, although
entitled to do so under Pennsylvania law, did not seek a
deficiency judgment against petitioners. As Countrywide viewed
the matter, following the foreclosure proceeding, petitioners
owed the company $22,035, computed by subtracting the lower range
of the Broker’s Price Opinion, that is $90,000 from the amount of
principal on the loan then outstanding, that is $112,035.
Because Countrywide did not seek a deficiency judgment against
2
The phrase “marketing time” as used in the valuation
report is not familiar to the Court, and neither party offered an
explanation as to what it means.
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petitioners, the company was precluded under State law from
collecting that amount. As evidenced in a Form 1099-C,
Cancellation of Debt, issued to petitioners by Countrywide,
$22,035 of the debt originating from the loan was forgiven during
2002.
Immediately preceding the foreclosure of the mortgage,
petitioners had assets totaling $133,715 and liabilities
totaling $155,505.59.3
Petitioners did not include any amount of cancellation of
indebtedness income on their 2002 return. In the notice of
deficiency respondent increased petitioners’ income by the amount
reported as cancellation of indebtedness on the Form 1099-C.
Other adjustments made in the notice of deficiency have been
agreed to by the parties.
Discussion
In general, the term “income” as used in the Internal
Revenue Code means income from any source, including income from
the discharge of indebtedness. Sec. 61(a)(12); Commissioner v.
Glenshaw Glass Co., 348 U.S. 426 (1955). In this case, during
the year in issue, Countrywide forgave $22,035 of the debt owed
to it by petitioners as a result of the loan. According to
respondent, that amount is includable in petitioners’ 2002
3
The stipulated amount shown for assets includes the value
of the residence at $90,000.
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income.
Petitioners claim that they were insolvent at the time of
the discharge, and, therefore, the amount of debt forgiven is
excludable from their 2002 income. See sec. 108(a)(1)(B).
For purposes of section 108(a)(1)(B) the term “insolvent”
means “the excess of liabilities over the fair market value of
assets” as determined “immediately before the discharge.” Sec.
108(d)(3). Respondent acknowledges that petitioners were
insolvent to the extent of $21,790.59 immediately before the
discharge. Nevertheless, relying upon an inapplicable regulation
and precedent from a case superseded by the enactment of section
108(a)(1)(B),4 respondent argues that “in order to qualify for
the insolvency exception, the taxpayer must be insolvent both
immediately before and immediately after the discharge of
indebtedness.” Respondent points out that petitioners have
failed to establish that they were insolvent immediately
following the discharge and argues that the provisions of section
108(a)(1)(B) do not apply. Petitioners’ financial status
immediately after the discharge, although disputed by the
parties, is, simply put, not relevant.
Turning our attention to petitioners’ financial status
immediately before the discharge, and otherwise ignoring various
4
Sec. 108 was amended by the Bankruptcy Tax Act of 1980,
Pub. L. 96-589, sec. 2(a), 94 Stat. 3389.
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of the parties’ positions that we find to have no merit, we make
the following findings regarding petitioners’ financial status
immediately before the discharge: (1) The fair market value of
the property subject to the foreclosure proceeding was $90,000
(per stipulation of the parties); (2) petitioners had other
assets totaling $43,715 (per stipulation of the parties); (3)
petitioners’ liability to Countrywide was not less than $143,280
(per stipulation of the parties); and (4) petitioners’ other
liabilities totaled not more than $12,224.79 (liabilities
substantiated per stipulation of the parties). Plugging these
amounts into the equation contemplated by the statute, we find,
as respondent acknowledges in his brief, that immediately before
the discharge, petitioners’ liabilities exceeded their assets by
$21,790.59, and therefore, within the meaning of section
108(a)(1)(B), petitioners were insolvent to that extent for
purposes of section 108.
Section 108(a)(3) limits the exclusion provided in section
108(a)(1)(B) to the “amount by which the taxpayer is insolvent.”
Applying the $21,790.59 exclusion against the $22,035 discharged
results in $244.41 that is includable in petitioners’ 2002
income as a result of the discharge of their indebtedness to
Countrywide.
Respondent imposed a section 6662(a) accuracy-related
penalty upon the ground that the underpayment of tax required to
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be shown on petitioners’ 2002 return is a substantial
understatement of income tax. Considering the foregoing, the
understatement will be far less than the amount required for the
imposition of the penalty. See sec. 6662(d). Respondent’s
imposition of the section 6662(a) accuracy-related penalty is
rejected.
To reflect the foregoing,
Decision will be entered
under Rule 155.