T.C. Memo. 2012-212
UNITED STATES TAX COURT
BERNARD R. SHEPHERD AND DESIREE SHEPHERD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26910-10. Filed July 24, 2012.
Bernard R. Shepherd and Desiree Shepherd, pro sese.
Kristina L. Rico, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
RUWE, Judge: Respondent determined a $1,613 deficiency in petitioners’
2008 Federal income tax. The issue for decision is whether petitioners are entitled
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to exclude from gross income under section 108(a)(1)(B)1 discharge of indebtedness
income of $4,412.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts and the attached exhibits are incorporated herein by this reference.
At the time the petition was filed, petitioners resided in New Jersey.
In November 2007 petitioners’ credit card company, Capital One Bank
(USA) N.A. (Capital One), referred petitioners’ delinquent account to an outside
collection agency. The principal loan balance due on petitioners’ Capital One
account at the time of the referral was $9,962.06. Petitioners entered into a
settlement agreement with the outside collection agency, agreeing to settle their
Capital One loan balance for $5,550. Petitioners made payments totaling $5,550
from March 28 to July 30, 2008. The outside collection agency then notified
Capital One that petitioners had paid the full amount required by the settlement
agreement. Capital One coded petitioners’ account as “Settled in Full” and
discharged the remaining liability on September 3, 2008.
1
Unless otherwise indicated, all section references are to the Internal Revenue
Code in effect for the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
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In January 2009 Capital One issued to Mr. Shepherd a Form 1099-C,
Cancellation of Debt, showing that $4,412 of indebtedness had been canceled on
September 3, 2008. Petitioners did not report the $4,412 as income on their 2008
joint Federal income tax return.
The parties did not dispute the fair market values of the following of
petitioners’ assets immediately before petitioners’ discharge:
Asset Fair Market Value
Cash $300.00
Cars 12,550.00
Computers 100.00
Household goods 2,100.00
Tools 50.00
Jewelry 4,000.00
Clothing 350.00
Books 25.00
Life insurance 1,108.24
Investments 10,223.79
Boat 300.00
Total 31,107.03
Likewise, the parties did not dispute the amounts of the following of
petitioners’ liabilities:
Liability Amount
Principal residence mortgage $555,015.31
Beach house mortgage 177,535.00
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Real estate taxes 14,091.24
Credit card debt 25,659.43
Car debt 8,519.98
Utilities 1,563.84
Loan from New Jersey Public
Employees Retirement System 15,532.75
Miscellaneous bills 936.91
Total 798,854.46
The parties disagree about the values of three assets which are not included in
the above lists. During 2008 petitioners owned a house in Mullica Hill, New Jersey
(principal residence), and a house in Brigantine, New Jersey (beach house).
Petitioners continued to own these houses at the time of trial in 2012. The parties
disagree about the values of these two houses. They also disagree about the value
of Mr. Shepherd’s pension in the New Jersey Public Employees Retirement System
(PERS).
OPINION
The Commissioner’s determinations in a notice of deficiency are presumed
correct, and the taxpayer bears the burden of proving that the determinations are in
error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
“Income from discharge of indebtedness” is included within the broad
definition of income. Sec. 61(a)(12). Section 108 provides certain exceptions to
section 61(a)(12). Section 108(a)(1)(B) excludes discharge of indebtedness income
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from gross income if the discharge occurs when the taxpayer is insolvent. The
amount of income excluded under section 108(a)(1)(B) “shall not exceed the
amount by which the taxpayer is insolvent.” Sec. 108(a)(3). The term “insolvent”
means “the excess of liabilities over the fair market value of assets.” Sec.
108(d)(3). Whether a taxpayer is insolvent, and the amount by which the taxpayer
is insolvent, is “determined on the basis of the taxpayer’s assets and liabilities
immediately before the discharge.” Id.
Respondent acknowledges that petitioners correctly listed the fair market
values of most of their assets and liabilities. Petitioners and respondent dispute
whether petitioners met their burden of proving the fair market values of the beach
house and the principal residence, which were petitioners’ largest assets.
Additionally, petitioners and respondent dispute whether Mr. Shepherd’s pension is
an asset for purposes of determining whether petitioners are insolvent under section
108(d)(3).
Burden of Proof Regarding the Fair Market Values of the Beach House and the
Principal Residence
“The burden of proving insolvency under section 108(a)(1)(B) is on
petitioners.” Bressi v. Commissioner, T.C. Memo. 1991-651, 1991 Tax Ct. Memo
LEXIS 693, at *18 (citing Rule 142(a) and Welch v. Helvering, 290 U.S. 111, 115
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(1933)), aff’d without published opinion, 989 F.2d 486 (3d Cir. 1993). Therefore,
petitioners have the burden of proving the fair market value of all their assets
immediately before the discharge.2 See sec. 108(d)(3).
Beach House
Respondent argues that petitioners have not met their burden of proving the
fair market value of their beach house immediately before the discharge. Petitioners
contend they offered sufficient evidence to prove that the fair market value of the
beach house was approximately $340,000.3
To support the fair market value of their beach house petitioners offered into
evidence a “Civil Action Stipulation of Settlement” (settlement) between petitioners
and the City of Brigantine. The settlement provides that the value of the beach
house for local property tax purposes is $380,000 for the 2010 tax year. Petitioners
signed the settlement on May 16, 2011.
2
In some cases the burden of proof with respect to relevant factual issues may
shift to the Commissioner under sec. 7491(a). However, petitioners have not argued
that the burden of proof should shift to respondent, nor have they produced credible
evidence as required by sec. 7491(a)(1). Therefore, we hold that the burden of
proof does not shift to respondent.
3
At trial Mr. Shepherd testified that petitioners purchased the beach house in
1996 for $118,000. Petitioners offered into evidence a Wells Fargo monthly
mortgage statement for the beach house loan showing the unpaid principal balance
of $177,539.03 on December 18, 2008.
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“This Court has held previously that a value placed upon property for the
purpose of local taxation, unsupported by other evidence, cannot be accepted as
determinative of fair market value for Federal income tax purposes in the absence of
evidence of the method used in arriving at that valuation.” Pierce v. Commissioner,
61 T.C. 424, 431 n.6 (1974); see Gilmartin v. Commissioner, T.C. Memo. 1973-
247, 1973 Tax Ct. Memo LEXIS 40, at *20-21; Bishop v. Commissioner, T.C.
Memo. 1962-146, 1962 Tax Ct. Memo LEXIS 163, at *61. The settlement does not
describe the beach house nor the method used to determine the value of the beach
house. Additionally, the settlement shows the beach house’s valuation for tax
purposes for 2010, whereas petitioners’ debt was discharged on September 3, 2008.
As a result, we find that the settlement is not convincing evidence of the fair market
value of the beach house immediately before petitioners’ discharge.
At trial Mr. Shepherd testified that in his opinion the value of the beach house
immediately before the discharge was approximately $340,000. Mr. Shepherd’s
valuation testimony was allegedly based on comparable sales that he assembled for
the purpose of a property tax appeal. Apparently, this was for the 2010 tax year,
which was at least two years after the discharge on September 3, 2008. While
comparable sales can be persuasive evidence of fair market value, see First Nat’l
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Bank of Kenosha v. United States, 763 F.2d 891, 896 (7th Cir. 1985), petitioners
neither offered into evidence nor described in detail the comparable sales or their
dates. In order to corroborate Mr. Shepherd’s testimony, the Court would need to
review the comparable sales to determine whether a proper valuation methodology
was used and that the comparable sales occurred in close proximity to the date of
discharge. As a result, we find that Mr. Shepherd’s testimony is not convincing
evidence of the fair market value of the beach house immediately before petitioners’
discharge.
Accordingly, we find that petitioners did not meet their burden of proving the
fair market value of the beach house immediately before the discharge.
Principal Residence
Respondent argues that petitioners have not met their burden of proving the
fair market value of the principal residence immediately before the discharge.
Petitioners contend they offered sufficient evidence to prove that the fair market
value of the principal residence was $380,000 immediately before the discharge.4
4
At trial Mr. Shepherd testified that petitioners obtained a $580,000 mortgage
on the principal residence in 2005. Mr. Shepherd further testified that in 2005 the
approximate appraised value of the principal residence was $750,000. Petitioners
offered into evidence a Chase monthly mortgage statement showing the unpaid
principal balance on the principal residence loan was $555,015.31 on August 15,
2008.
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Petitioners offered the following evidence to support their valuation: (1) a letter
dated March 29, 2011, from Chase Home Finance LLC (Chase) showing the value
of the principal residence; and (2) a “2008 Final/2009 Preliminary Tax Bill” (tax
bill).
Petitioners applied for a loan modification for the principal residence through
the Federal Home Affordable Modification Program (HAMP). As part of Chase’s
review to determine whether petitioners’ loan qualified for a HAMP modification,
Chase had to value petitioners’ principal residence. In a letter Chase informed
petitioners that an “exterior broker price opinion/appraisal”5 was used to value the
property as of March 2011 at $380,000.
Section 108(d)(3) requires that the fair market value of a taxpayer’s assets be
determined “immediately before the discharge.” Chase determined the fair market
value of the principal residence as of March 2011, almost three years after the date
of petitioners’ discharge.6 Furthermore, the letter from Chase does not describe the
property nor explain, even briefly, the methodology used to determine its value. We
find that Chase’s valuation of the principal residence as of March 2011 is not
5
The letter from Chase does not explain what “exterior broker price
opinion/appraisal” means.
6
We take judicial notice of the large downturn in national residential real
estate values that occurred after September 2008.
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convincing evidence of the fair market value of the principal residence immediately
before petitioners’ discharge.
Petitioners offered into evidence a tax bill they received for their principal
residence. The tax bill shows a net taxable value of $337,700 for petitioners’
principal residence. The tax bill does not describe the property in detail nor the
methodology used in determining the tax value. As we noted earlier, a value placed
upon property for local taxation purposes is not determinative of fair market value of
the property for Federal income tax purposes in the absence of evidence of the
method used in arriving at that valuation. See Pierce v. Commissioner, 61 T.C. at
431 n.6; Gilmartin v. Commissioner, 1973 Tax Ct. Memo LEXIS 40, at *20-21;
Bishop v. Commissioner, 1962 Tax Ct. Memo LEXIS 163, at *61.
Furthermore, in New Jersey the assessed value of property is generally not
equivalent to the fair market value of the property. See City of Passaic v. Passaic
Cnty. Bd. of Taxation, 113 A.2d 753, 756 (1955) (“There has been general
agreement for over a century that individual property valuations and assessments
have been and are marred by the grossest inequities.”). In fact, the statutory
framework for property assessments in New Jersey specifically contemplates that
the assessed value of a property for tax purposes will not be equivalent to the fair
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market value of the property. See N.J. Stat. Ann. sec. 54:3-17 (West 2002) (each
county tax administrator must annually determine the “ratio or percentage of true
value at which the real property of each taxing district is in fact assessed”); id. sec.
54:1-35.3 (The director of the division of taxation must determine the “ratio of
aggregate assessed to aggregate true valuation of real estate of each taxing
district.”).
We find that the tax bill is not convincing evidence of the fair market value of
the principal residence. We further find that petitioners have not met their burden of
proving the fair market values of the principal residence and the beach house
immediately before the discharge. Accordingly, petitioners have failed to establish
that they were insolvent as defined in section 108(d)(3).
Mr. Shepherd’s Pension
We have previously found that petitioners were not insolvent as defined in
section 108(d)(3) because they failed to meet their burden of proving the fair market
values of the beach house and the principal residence. Nevertheless, we will discuss
whether Mr. Shepherd’s pension is an asset because the parties have discussed this
issue extensively.
Petitioners contend that Mr. Shepherd’s pension is not an asset for purposes
of determining insolvency under section 108(d)(3). Respondent disagrees.
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Mr. Shepherd is employed by Gloucester township and is a contributing
member of PERS. On March 21, 2007, Mr. Shepherd obtained a $21,973.30 loan
from PERS against his pension. Mr. Shepherd testified that this amount was the
maximum he could borrow from PERS. On May 1, 2007, Mr. Shepherd made his
first of 58 monthly loan repayments of $378.85 to PERS. Mr. Shepherd continued
making contributions to his pension after he received the loan.
Petitioners classified Mr. Shepherd’s loan from PERS as a liability under
section 108(d)(3). We note that it is wholly inconsistent to show a loan as a liability
if the loan is fully secured by collateral and the collateral is not listed as an asset.
By including the loan and not the underlying collateral, petitioners are presenting
themselves as more insolvent than the reality of the matter. For consistency
purposes, petitioners must either remove the loan as a liability or include the
collateral that secures the loan as an asset.
The term “insolvent” means “the excess of liabilities over the fair market
value of assets.” Sec. 108(d)(3). This Court has held that the word “assets” as used
in the definition of the term “insolvent” for section 108(d)(3) includes “assets
exempt from the claims of creditors under applicable State law.” Carlson v.
Commissioner, 116 T.C. 87, 105 (2001). We reasoned that if a debtor’s assets,
including assets exempt from the claims of creditors under State law, exceed
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liabilities, then the debtor has the ability to pay a tax on income from the discharge
of indebtedness. Id. at 104. Mr. Shepherd’s pension is exempt from claims of
creditors under New Jersey State law. See N.J. Stat. Ann. sec. 25:2-1 (West 1997
& Supp. 2012). Under the Court’s holding in Carlson, Mr. Shepherd’s pension will
not escape classification as an asset under section 108(d)(3) solely because of its
exemption from claims of creditors.
Mr. Shepherd had the ability to withdraw some portion of his pension on the
date of petitioners’ discharge. A member of PERS “may borrow from the
retirement system, an amount equal to not more than 50% of the amount of his
accumulated deductions”. N.J. Stat. Ann. sec. 43:15A-34 (West 1991 & Supp.
2012). A member of PERS may have more than one loan outstanding at any time.
See id. Mr. Shepherd continued making contributions to his pension with PERS
every pay period from the date he received the loan from PERS to the date of
petitioners’ discharge. Additionally, during this period Mr. Shepherd made monthly
loan repayments of $378.85 to PERS. In other words, Mr. Shepherd’s loan balance
with PERS decreased from the date he obtained the loan to the date of petitioners’
discharge while his accumulated contributions to his pension increased over that
period. Therefore, we note that Mr. Shepherd’s outstanding loan balance on the
date of petitioners’ discharge must have been less than 50% of his accumulated
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contributions to his pension. As a result, Mr. Shepherd had the right to immediately
withdraw some portion of his accumulated contributions as a loan from his pension
with PERS immediately before petitioners’ discharge of indebtedness. We find that
the portion of Mr. Shepherd’s pension that could have been withdrawn as a loan
from PERS is an asset for purposes of insolvency under section 108(d)(3).7
Petitioners did not provide any evidence of Mr. Shepherd’s accumulated
contributions to the pension immediately before the discharge. Therefore, we are
unable to determine what portion of Mr. Shepherd’s pension could have been
withdrawn as a loan. Accordingly, we find that petitioners have not met their
burden of proving the fair market value of the portion of Mr. Shepherd’s pension
that constitutes an asset.
Conclusion
Section 108(d)(3) requires that a taxpayer establish the fair market value for
all of his assets and liabilities in order to make a determination of insolvency. If we
were to accept petitioners’ valuation of their houses and exclude from liabilities the
loan from PERS, petitioners would be approximately $32,000 insolvent. However,
7
Therefore, it is unnecessary for us to decide whether Mr. Shepherd’s entire
pension constitutes an asset under sec. 108(d)(3).
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petitioners have not met their burden of proving the fair market values of the beach
house, the principal residence, and Mr. Shepherd’s pension. Since petitioners have
not established they were insolvent as defined in section 108(d)(3), petitioners are
not entitled to exclude their discharge of indebtedness income from gross income
under section 108(a)(1)(B).
In reaching our decision, we have considered all arguments made by the
parties, and to the extent not mentioned or addressed, they are irrelevant or without
merit.
To reflect the foregoing,
Decision will be entered for
respondent.