T.C. Summary Opinion 2016-74
UNITED STATES TAX COURT
KARL D. BOBO AND KIMBERLY D. BOBO, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15840-15S. Filed November 8, 2016.
Karl D. Bobo and Kimberly D. Bobo, pro sese.
Annie Lee, Thomas R. Mackinson, and Michael Skeen, for respondent.
SUMMARY OPINION
PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in effect when the
petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not
1
Unless otherwise indicated, subsequent section references are to the
(continued...)
2
reviewable by any other court, and this opinion shall not be treated as precedent
for any other case.
In a notice of deficiency dated March 23, 2015, respondent determined a
deficiency of $7,175 in petitioners’ Federal income tax for 2012. The issue for
decision is whether petitioners’ receipt in 2012 of $20,500 designated by the payor
as payment for a deed in lieu of foreclosure is ordinary income. Respondent also
determined that petitioners are liable for an alternative minimum tax of $410. This
is a computational adjustment dependent on the outcome of the disputed issue.
Background
Some of the facts have been stipulated, and we incorporate the stipulation of
facts by this reference. Petitioners resided in California when the petition was
timely filed.
Petitioners Karl D. Bobo (petitioner husband) and Kimberly D. Bobo were
residing in California during the year in issue. In 2008 petitioners owned their
primary residence in California (California house) but worked in management
positions requiring frequent travel to North Carolina. For this reason petitioners
purchased a second house in North Carolina (North Carolina house) in March
1
(...continued)
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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20082 for $850,000. Petitioners secured a nonrecourse mortgage note to finance
90% of the purchase price and made a downpayment of $85,000.
Sometime before May 2012 petitioners began experiencing financial
difficulties and sought loan modifications from the companies holding mortgages
on the California and North Carolina houses. Although petitioners did not qualify
for a loan modification for the loan on the North Carolina house, the mortgage
company Green Tree Services, LLC (Green Tree), informed petitioners that they
might qualify for a “deed in lieu of foreclosure” (deed in lieu of foreclosure)
program. Since petitioners could no longer afford to make payments on the North
Carolina mortgage loan, they applied for and were accepted into this program.
In May 2012 petitioners entered into a deed in lieu of foreclosure agreement
with Green Tree that included a “cash for keys” (cash for keys) payment. Under
the terms of this agreement petitioners signed the deed over to Green Tree and in
exchange the mortgage company forgave the balance of petitioners’ note on the
property. Petitioners also agreed to vacate the property by a certain time and meet
other specified requirements, including leaving the property in “broom-swept
condition”, and in exchange petitioners would receive a cash for keys payment.
2
Petitioners’ tax return reported the purchase date of March 26, 2008.
Petitioners executed the promissory note relating to the purchase of the house on
January 23, 2008.
4
The cash for keys program was designed by mortgage lenders to allow them
to gain possession of a property quickly and avoid a long foreclosure process.
Lenders began issuing these payments in exchange for borrowers’ vacating a
property quickly and leaving it in good condition. A foreclosure process to
reclaim a property can be time consuming, causing a lender to spend time and
money and risk further damage to the property.3
Petitioners provided a copy of the letter from Green Tree’s law firm
Hutchens, Senter, Kellam, & Petit, P.A. dated May 4, 2012. The letter stated that
“you have agreed to sign a deed in lieu of foreclosure on your property” in North
Carolina. The letter instructed petitioners as follows:
Please sign the enclosed Deed, Marital Status Affidavit(s), Affidavit
Regarding Liens, and Estoppel Affidavit before a Notary Public and
return these documents to our office no later than 5/25/2012 and
vacate by 5/25/2012. A property inspection will be ordered by Green
Tree on or after 5/25/2012. Based on your agreement with the lender
$20,500.00 cash for keys incentive will be issued by Green Tree once
Green Tree confirms property is vacant and in broom swept
condition.
Also please send evidence/information that assessments and
homeowners association dues if any are paid in full to the transfer
date unless other agreements regarding these items have been
previously approved by the lender, and forward all keys to the subject
3
Respondent provided this explanation at trial, and petitioners did not
dispute the nature of the cash for keys program.
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property, if you have any in your possession, to our office when you
return the documents mentioned above.
Petitioners also provided copies of the marital status affidavit, warranty
deed, affidavit regarding liens, and estoppel affidavit, all dated May 21, 2012,
executed as part of the agreement described in the letter dated May 4, 2012. The
warranty deed and the estoppel affidavit reflect that petitioners signed the deed to
the North Carolina house and agreed to vacate it by May 25, 2012, in exchange for
Green Tree’s canceling the note on the North Carolina house.
Green Tree issued a Form 1099-MISC, Miscellaneous Income, for the cash
for keys payment in petitioner husband’s name and categorized the $20,500 in box
7 as “nonemployee compensation”.4 Green Tree also issued a Form 1099-A,
Acquisition or Abandonment of Secured Property, to petitioner husband. The
Form 1099-A reported an acquisition date of May 29, 2012, a loan principal
balance outstanding of $716,426, and fair market value of the property of
$607,500.5
4
Petitioner husband did not work for Green Tree. The parties agree that
Green Tree issued the Form 1099-MISC for the cash for keys incentive payment.
5
Green Tree calculated the cancellation of debt income of $108,926 as
follows:
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Petitioners timely filed a joint Form 1040, U.S. Individual Income Tax
Return, for 2012 on July 11, 2013.6 Harry Bergland, Jr., a certified public
accountant, prepared the 2012 Federal income tax return. Petitioners attached to
their Form 1040 a Form 8949, Sales and Other Dispositions of Capital Assets,
relating to disposition of the North Carolina house. On Form 8949 petitioners
claimed a cost basis of $850,000 in the North Carolina house and gross proceeds
of $736,926 from the deed in lieu of foreclosure transaction with Green Tree,
resulting in a loss of $113,074.7
5
(...continued)
Cancellation of debt income
Loan principal balance outstanding $716,426
Fair market value of property (607,500)
Total income 108,926
6
Petitioners attached to their Form 1040 a Form 4868, Application for
Automatic Extension of Time to File U.S. Individual Income Tax Return.
7
Mr. Bergland calculated petitioners’ gross proceeds by adding the cash for
keys incentive payment to the fair market value of the North Carolina house and
the cancellation of debt income.
(continued...)
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Respondent issued a notice of deficiency dated March 23, 2015,
reclassifying the $20,500 payment from Green Tree as ordinary income.
Petitioners timely filed their petition on June 18, 2015, contesting the notice of
deficiency and asserting “the return is correct as originally filed”.
Discussion
I. Burden of Proof
In general, the Commissioner’s determination set forth in a notice of
deficiency is presumed correct, and the taxpayer bears the burden of proving that
the determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Pursuant to section 7491(a), the burden of proof as to factual matters
shifts to the Commissioner under certain circumstances. Petitioners did not allege
or otherwise show that section 7491(a) applies. See sec. 7491(a)(2)(A) and (B).
Therefore, petitioners bear the burden of proof. See Rule 142(a).
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(...continued)
Calculation of gross proceeds Calculation of loss
Cash for keys payment $20,500 Gross Proceeds $736,926
Fair market value 607,500 Cost basis (850,000)
Cancellation of debt Loss 113,074
income 108,926
Total proceeds 736,926
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II. Deed in Lieu of Foreclosure and Cash for Keys Payment
Section 61(a) defines gross income as “all income from whatever source
derived” and includes compensation paid for services, whether furnished by the
taxpayer as an employee or as a self-employed person or independent contractor.
Gains derived from the sale or exchange of property are included in gross income
unless excluded by law. Sec. 1.61-6(a), Income Tax Regs. The specific rules for
computing gain or loss on the sale of property are governed by section 1001. Id.
It is “well settled” that the transfer of property by deed in lieu of foreclosure
constitutes a “sale or exchange” for Federal income tax purposes. Allan v.
Commissioner, 86 T.C. 655, 659 (1986), aff’d, 856 F.2d 1169 (8th Cir. 1988);
Freeland v. Commissioner, 74 T.C. 970, 979 (1980); Lowry v. Commissioner, T.C.
Memo. 2003-225, aff’d, 171 F. App’x 6 (9th Cir. 2006). The gain or loss
recognized on this “sale or exchange” is the difference between the amount
realized from the disposition and the property owner’s adjusted basis. Sec.
1001(a). The amount realized from the disposition is the sum of any money
received in the transfer plus the fair market value of property (other than money)
received. Sec. 1001(b). When a taxpayer’s obligation to repay a nonrecourse
mortgage is extinguished, he includes the amount of the extinguished debt in his
amount realized under section 1001(b). Allan v. Commissioner, 86 T.C. at 661;
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sec. 1.1001-2(a)(1), Income Tax Regs.; see also Commissioner v. Tufts, 461 U.S.
300, 317 (1983); Crane v. Commissioner, 331 U.S. 1 (1947). The taxpayer’s
adjusted basis is generally a cost basis. Sec. 1012(a).
The Court looks to the substance of the transaction when determining how a
deed in lieu of transaction or a similar exchange is taxed. 2925 Briarpark, Ltd. v.
Commissioner, T.C. Memo. 1997-298, 1997 WL 357880, at *4, aff’d, 163 F.3d
313 (5th Cir. 1999). In 2925 Briarpark, Ltd. v. Commissioner, 1997 WL 357880,
at *1, a partnership secured a loan to purchase a parcel of land and finance
construction of a building. The partnership converted the loan to a nonrecourse
loan and later defaulted on the loan. Id., 1997 WL 357880, at *1-*2. After
defaulting, the partnership found a third party willing to purchase the property
upon the satisfaction or removal of its encumbrances, which included a lien by the
bank holding the taxpayer’s loan. Id. at *2. The bank agreed to release the
partnership from the lien and the nonrecourse loans if the partnership met the
following conditions: (1) sale of the property to the third party for a minimum sale
price of $11.6 million; (2) assignment of the sale proceeds to the bank; (3) transfer
of the partnership’s cash reserves of $177,495 to the bank; and (4) a $175,000
payment by the partnership’s general partner. Id. The partnership met all of the
bank’s conditions by selling the property, assigning the sale proceeds to the bank,
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and transferring the cash from the partnership and the general partner. Id. The
bank subsequently released the property from the lien and nonrecourse loan,
resulting in cancellation of $14 million of indebtedness. Id. at *2-*3.
The Court held that the “the sale of the property, the transfer of $177,495
cash, and the assignment of the sale proceeds * * * has the same practical effect as
several other transactions which have been held to be a ‘sale or exchange.’” Id. at
*4. The transaction is the “functional equivalent of a foreclosure, reconveyance in
lieu of foreclosure, abandonment, or repossession” and “[a]ny differences * * * are
not in substance, but in form.” Id. The Court did not treat the cash sale and the
discharge of the loan as two independent events because “[t]he record before us
* * * is replete with evidence” that the sale and the discharge were the result of a
single transaction, the sale of the property. Id. at *5.
On the basis of this record we are satisfied that the deed in lieu of
foreclosure and the cash for keys incentive are the results of a single transaction.
Similar to the partnership in 2925 Briarpark, Ltd., which had multiple agreements
relating to the exchange of the property, petitioners had two agreements with
Green Tree stemming from the exchange of property: the deed in lieu of
foreclosure agreement and the cash for keys agreement. Looking at the substance
of the transaction the two agreements are inseparable; Green Tree would not have
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issued the cash for keys payment but for petitioners’ agreeing to sign over the deed
to the property. Thus the cash for keys payment should be treated as part of the
deed in lieu of foreclosure transaction and included in the amount realized on the
North Carolina house. See sec. 1001(b) (amount realized includes money
received); 2925 Briarpark, Ltd. v. Commissioner, 1997 WL 357880, at *4-*5.8
As a result, we calculate the gross proceeds from the transaction by adding
the cash for keys incentive payment to the amount of loan forgiveness.
Petitioners’ basis in the property is their cost basis.9 See secs. 1001(a) and (b),
1012(a); sec. 1.1001-2(a)(1), Income Tax Regs.
Respondent argues that the $20,500 cash for keys payment is an incentive
payment which petitioners received only by fulfilling the conditions of the cash for
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The Court recognizes that 2925 Briarpark, Ltd. relates to the inclusion of
proceeds from extinguishment of debt in the amount realized on the “sale or
exchange” of a property and treatment of multiple agreements as part of a single
property sale or exchange transaction. We extend these general principles to apply
to the situation in which the lender made a cash for keys payment to petitioners in
addition to cancellation of indebtedness.
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This achieves the same result as petitioners’ calculation on their return.
Calculation of proceeds Calculation of loss
Cash for keys payment $20,500 Gross proceeds $736,926
Balance of loan forgiven 716,426 Cost basis (850,000)
Total proceeds 736,926 Loss 113,074
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keys program. Respondent asserts that this incentive payment is not part of the
amount realized in the exchange and should instead be considered ordinary
income. It is clear from the record that Green Tree did not hire petitioner husband
for services or have another reason to issue the cash for keys payment. See sec.
61(a); sec. 1.61-6(a), Income Tax Regs. Rather, the cash for keys payment was
part of a single transaction, the property sale or exchange; Green Tree paid
petitioners $20,500 to avoid the lengthy and expensive legal process of foreclosure
as part of the deed in lieu of foreclosure process. The two agreements are
inextricably linked, and there is no basis for treating them separately. See 2925
Briarpark, Ltd. v. Commissioner, 1997 WL 357880, at *4-*5.
We have considered all of the parties’ arguments, and, to the extent not
addressed herein, we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for petitioners.