Respondent determined deficiencies in petitioners' Federal income tax for the years 1988 and 1989 in the amounts of $6,887.00 and $13,643.00, respectively.
All the facts have been stipulated and are found accordingly. Petitioners resided in Cascade, Iowa, at the time they filed their petition.
As of December 30, 1988, Production Credit Association (Production) held a recourse note from petitioners with a balance due of $152,260. At that time, petitioners were unable to make the required payments. Pursuant to a restructuring agreement, petitioners transferred to Production on December 30, 1988, 60 acres of farmland having a fair market value of $39,000 and a basis of $14,384 and, on January 4, 1989, an additional 141 acres having a fair market value of $77,725 and a basis of $32,080. Pursuant to the agreement, petitioners also paid $6,123 in cash to be applied towards the outstanding balance, and their remaining debt to Production was forgiven. Petitioners were not debtors under title 11 of the U.S. Code (the bankruptcy code) at any time during 1988 and 1989 but were insolvent both before and after the transfers and the discharge of indebtedness. Respondent concedes that the amount of the indebtedness in excess of the fair market value of the transferred land constitutes income from the discharge of indebtedness excludable under section 108.
Respondent contends that the transfers in partial satisfaction of petitioners' indebtedness constitute gains taxable under sections 61(a)(3) and 1001, that such gains do not constitute income from discharge of indebtedness, and that therefore they are not excludable under section 108. Petitioners contend that, because of their insolvency, they realized nothing of value from the gains in question, that such gains should be characterized as income from discharge of indebtedness under section 61(a)(12), and that therefore they are excludable under section 108. We hold for respondent.
It is well settled that a transfer of property by a debtor to a creditor in satisfaction, in whole or in part, of an indebtedness constitutes a "sale or exchange" under section 1001 and that the excess of the fair market value over basis of the property applied against the indebtedness constitutes taxable
SEC. 108(a). EXCLUSION FROM GROSS INCOME. —
At the outset, we note that petitioners' obligation was recourse and not nonrecourse, and that respondent has conceded that the amount of the gain represented by the excess of the amount of the debt over the fair market value of the property transferred constitutes cancellation of indebtedness not includable in gross income because of petitioners' insolvency. Under these circumstances, only the amount of the gain represented by the excess of such fair market value over basis is at issue, and we need not and do not resolve any issue of bifurcation
Petitioners seek to distinguish Danenberg on the ground that the transfers therein were to third parties and not to the creditor. In point of fact, part of the property transferred (the Meloland stock) in that case was to a nominee of the creditor who simply stood in the shoes of the creditor and did not constitute a third party as did transferees of other property. See Danenberg v. Commissioner, supra at 374, 386; Cunningham, supra at 613. Moreover, our analysis in Danenberg was constructed in the context of our observation that
Case law is clear that when a debt is discharged or reduced upon the debtor's transfer of property to his creditor or a third party, such transaction is treated as a sale or exchange of the debtor's assets, and not as a mere transfer of assets in cancellation of indebtedness. * * * [Danenberg v. Commissioner, supra at 380-381; fn. ref. and citations omitted.]
Petitioners' reliance on Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 F.2d 95 (5th Cir. 1934), revg. 27 B.T.A. 651 (1933), and Lakeland Grocery Co. v. Commissioner, 36 B.T.A. 289 (1937), is misplaced. Those cases were decided upon the basis of the impact of insolvency on the transaction as a whole without any consideration of the possibility of bifurcation of the transaction between the gain and the discharge of indebtedness elements.
As we see it, paragraphs (3) and (12) of section 61(a) are separate, independent, and not overlapping provisions in respect of the includability of a particular item in income. Danenberg v. Commissioner, supra. Consequently, the first steps in analyzing the consequences of a transfer of property in satisfaction of an indebtedness, in whole or in part, are to determine whether (1) gain or loss occurred under section 61(a)(3), and/or (2) there was cancellation of indebtedness under section 61(a)(12). Danenberg v. Commissioner, supra at 380; see also Home Builders Lumber Co. v. Commissioner, 165 F.2d 1009 (5th Cir. 1948), affg. a Memorandum Opinion of this Court dated Dec. 9, 1946; Cunningham, supra at 623. Only after it is determined that the latter provision applies does one reach the question of the impact of insolvency and therefore the applicability of section 108. This approach conforms precisely to the language of section 108(a)(1), which applies only to income "which (but for this subsection) would be includible in gross income by reason of the discharge * * * of indebtedness of the taxpayer", see supra p. 786. In this connection, we think it significant that section 108, by its terms, is the exclusive exception from "the general rule that gross income includes income from the discharge of indebtedness". Sec. 108(e)(1); see Trower, Federal Taxation of Bankruptcy and Workouts, par. 3.02, at 3-8 to 3-9 (1993).
In sum, we reaffirm Danenberg v. Commissioner, supra, and hold that section 1.1001-2, Income Tax Regs., see supra
In order to take into account an adjustment resulting from a concession by respondent in respect of the excess of the indebtedness above the fair market value of the property transferred, see supra p. 785,
Decision will be entered under Rule 155.
(a) Inclusion in amount realized. — (1) * * *
(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). For situations where amounts arising from the discharge of indebtedness are not realized and recognized, see section 108 and § 1.61-12(b)(1).
* * * * * * *
(c) Examples. * * *
Example (8). In 1980, F transfers to a creditor an asset with a fair market value of $6,000 and the creditor discharges $7,500 of indebtedness for which F is personally liable. The amount realized on the disposition of the asset is its fair market value ($6,000). In addition, F has income from the discharge of indebtedness of $1,500 ($7,500 - $6,000).
(b) Proceedings under Bankruptcy Act. (1) Income is not realized by a taxpayer * * * by virtue of an agreement among his creditors not consummated under any provision of the Bankruptcy Act, if immediately thereafter the taxpayer's liabilities exceed the value of his assets. * * *