Electing out of home equity indebtedness
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FOR TAX PROFESSIONALS
TAX NOTES - Electronic Edition - September 2001
*******************
"ELECTING OUT" OF HOME EQUITY INDEBTEDNESS
What to do if your client uses a home equity loan for business or
investment
Contents:
* Introduction
* Electing Out of QRI
* Mixed Use of Proceeds
* Taxpayer Elections
* Fragmentation
* Consequences of a Fragmented Election
* Conclusion
Introduction:
Qualified Residence Interest (QRI), which includes interest on
acquisition indebtedness and home equity indebtedness, is excepted,
under Section 163(h)(3), from the disallowance of the deduction for
personal interest. Both types of indebtedness must be secured by a
qualified residence, but, unlike acquisition indebtedness, home equity
indebtedness may be used for purposes other than acquiring,
construction, or improving the residence. Debt qualifying as home
equity indebtedness, however, is limited to $100,000. In addition,
since QRI is included in itemized deductions which may be limited in
the case of high income taxpayers, there is the possibility that only
20 percent of QRI may be deductible. Thus, the ability to elect out of
home equity treatment has become increasingly important.
Electing out of QRI:
Temporary Regulations Section 1.163-10T(o)(5) provides that a taxpayer
can elect to treat home equity debt as not secured by the residence,
thus freeing the debt from the dollar limitation and making it
available for the general interest deduction, if applicable. If,
however, the election is in effect and the debt proceeds are used for
personal purposes, the interest deduction is lost since it no longer
meets the QRI exception. The election may be revoked only with the
consent of the Internal Revenue Service.
A taxpayer may elect to treat any debt that is secured by a qualified
residence as not secured, as shown in the following example.
Example 1. A taxpayer has incurred debts A, B and C, all secured
by the taxpayer's
qualified residence. The proceeds of B were allocable (under the
tracing rules) to the
taxpayer's business. If the taxpayer elects to treat B as not
secured by the residence,
it would not be charged against the limitation on qualified debt,
and the interest would
be deductible as a business expense, assuming that it was
otherwise allowable under
Section 163(a).
Apparently, Congress intended that such interest would not be
characterized as business interest without the election. The
Conference Report accompanying TRA ?86 noted, for example, that
interest on a refinancing secured by the taxpayer's residence "is
treated as qualified residence interest, regardless of the purpose for
which the borrowed funds are used by the taxpayer." [H.R. Rep. No.
841, 99th Cong., 2d Sess. II-155 (1986)]
Temporary Regulation 1.163-8T(m)(3) provides: "... qualified
residence interest (as defined in IRC Sec 163(h)(3) is not taken into
account in determining the income or loss ... for purposes of (passive
activities) ... or in determining the amount of investment
interest ...".
Mixed Use of Proceeds:
The regulations do not address whether a taxpayer can make the
election with regard to only a portion of a debt. One commentator
noted that if, for example, a taxpayer used a portion of the proceeds
of a second mortgage for business purposes, then if the temporary
regulation "encompasses an election to treat a specified portion of a
debt as unsecured, [the taxpayer] can use the election to shift the
interest deduction attributable to the home equity debt from Schedule
A to Schedule C". [Jones, "Planning With the Interest Tracing Rules--
Doubts Remain," 70 J. Tax'n 216, 219 (1989)]
Example 2. A taxpayer borrows $50,000 on a home equity line of
credit to pay
$10,000 of business expenses and $40,000 of personal debt. The
taxpayer wishes
to make the election to treat only the $10,000 as not secured by
the residence.
This example raises the issues of not only whether an election can
be made for a part of the debt but also, if such fractional election
is not allowed, whether the election will be null and void or
effective for the entire debt.
Taxpayer Elections:
Tax elections are generally provided for in the Internal Revenue
Code, with guidance found in the regulations. The election to treat
home equity debt as not secured by a residence, however, is itself
granted in the regulations. Congress "clarified" that the IRS "may
prescribe the manner of making of any election by any reasonable
means". [Comm Rpt accompanying 1998 Act amendment to IRC Sec 7805(d)]
Congress and the courts have been adamant in forcing clarity of
the taxpayer's position with respect to elections. Justice Oliver
Wendell Holmes was brief and to the point when he wrote, in another
context but appropriate to elections: "Men must turn square corners
when they deal with the Government. If it attaches even purely formal
conditions ... those conditions must be complied with. ...[T]he words
are there in the statute and the regulations, and ... they mark the
conditions of the claimant's right." [ Rock Island, Ark., & La., R.R.
Co., 254 U.S. 141 (1920)]
Specifically on elections, the U.S. Supreme Court stated: "[T]hat
opportunity was afforded as a matter of legislative grace; the
election had to be made in the manner and in the time prescribed by
Congress. ... If [the taxpayer's] view were adopted, taxpayers with
the benefit of hindsight could shift from one [method] to another in
light of developments subsequent to their original choice." [Riley
Inv. Co. V. Comm'r, 311 U.S. 55 (1940)]
Perhaps a relatively recent Tax Court memorandum case best
summarized the concept, stating: "The courts should not impute to a
[taxpayer] a pivotal status for Federal income tax purposes that has
not been firmly and clearly elected." [Smith v. Comm'r, T.C. Memo
1988-18] See also Thurman, (T.C. Memo 1998-233) for an excellent
discussion re "substantial compliance" vs "conflicting actions"
regarding elections in the text surrounding endnotes 10 & 11.
Fragmentation:
Temporary Regulations Section 1.163-10T(o)(5) permits an election
for "any debt", and, in the example therein, the election was applied
to one of three separate debts. It may be difficult to overcome a
presumption that the regulation precludes fragmentation and that, in
so limiting the election, the Service did not abuse its authority.
A private letter ruling issued in 1993 (PLR 9335043) is premised
upon the condition that the temporary regulation (which had been
written to apply to the Code as it existed for the year 1987) applies
after 1987. More noteworthy is that it sheds some light on the
Service's position on a "fragmented" election, stating: "... if (the
taxpayer) makes the election ... NO PART ... will be qualified
residence interest ..." (emphasis added). To the best of this writer's
knowledge, there has been no litigation on this issue.
Note also that IRS Publication 936, since at least 1992, has
provided for this election as a "choice" to treat the debt as not
secured - "... you can choose to treat ANY DEBT secured by your
qualified home as not secured by the home..." (emphasis added).
Consequences of a Fragmented Election:
A similar dilemma regarding whether fragmentation would be allowed
was faced in TRA ?86, where a separate net operating loss (NOL)
calculation under the alternative minimum tax (AMT) forced taxpayers
to consider electing to forgo the AMT NOL carryback period on the
condition that the taxpayer was not simultaneously required to forgo
the regular NOL carryback. The Staff of the Joint Committee on
Taxation recognized the need for clarification, and concluded that the
election could not be fragmented.
In Plumb v Comm'r, 97 T.C. 632 (1991) the Tax Court held that
fragmenting the NOL election rendered the election invalid. Compare
this result to Branum, 17 F.3d 805, CA-5 (1994) in which the court
held that the election had been affirmatively made, even though a
state of confusion existed at the time of the election as to whether
it could be fragmented. However, also see Miller, Bradley C, 99 F.3d
1042 (CA-11, 1996) which held that use of the singular "loss" (instead
of "losses") in the election created sufficient ambiguity to negate
the election to forego the carryback.
The Federal Tax Division, American Institute of CPAs in Comments
on Temporary Regulations dated March 16, 1988, requested clarification
of how the election is to be made. If a taxpayer can interpret the
Publication 936 commentary to mean that by characterizing the interest
the taxpayer has made the election, the question of whether an
"invalid" election results if the resulting interest deduction is
fragmented is not as clearly defined as in the Plumb case (above).
Conclusion:
It appears clear that the tracing rules would apply if an election
was found effective as to the entire debt. Thus, in example 2 (above),
tracing could result in 80 percent of the interest being nondeductible
personal interest as the price for attempting to treat 20 percent as
business use. In addition, the 20 percent accuracy-related penalty
could apply.
Taxpayers obviously will have more certainty as to the
consequences of such transactions if they take out separate loans
where proceeds are to be used for mixed purposes. The taxpayer can
make the election as to only the business-purpose loan.
This material should be viewed only as a general summary of the
tax law as of its indicated date, and not as a substitute for tax
consultation in a particular case. Your questions and comments would
be appreciated.
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Internal Revenue Service (I.R.S.)
Private Letter Ruling
Issue: September 3, 1993
June 8, 1993
Section 163 -- Interest
163.00-00 Interest
163.03-00 Limitation on Investment Interest in General
CC:DOM:IT&A:02 / TR-31-50-93
A = ***
B = ***
C = ***
X = ***
Y = ***
x = ***
y = ***
z = ***
Dear ***
This responds to your letter on behalf of A, requesting rulings on the
following questions, all relating to the factual situation set forth
below:
(1) That the interest income received by A from X is investment income
under section 163(d)(4)(B) of the Internal Revenue Code, to be
reported on Schedule B of A's personal federal income tax return.
(2) That the interest paid by A to the bank on the mortgage secured by
the residence is interest on indebtedness properly allocable to
property held for investment, under section 163(d)(3)(A).
(3) That the interest paid to the bank is deductible by A as
investment interest, subject to the limitations of section 163(d).
The facts as presented in your letter are these. A seeks to obtain a
mortgage of x value from a bank using as security A's primary
residence. The proceeds from this mortgage will, in turn, be loaned to
X, a general partnership. B and C, adult children of A, are equal
partners in X. Both A and X are on the cash method of accounting, and
both have as their taxable year the calendar year. X owns commercial
office and warehouse property. The main tenant of this property is Y,
a manufacturer and wholesale distributor owned by A and B. A's
ownership interest is y, and B's ownership interest is z. X has an
existing balloon mortgage on the property it owns and proposes to use
its loan from A to pay off the balloon mortgage. X will pay a rate of
interest to A that is 1 percent above the interest rate A will pay to
the bank in interest on the mortgage. X will amortize the loan over
its term. The term of the mortgage from the bank to A and the term of
the loan from A to X will be the same. A will elect to treat the
mortgage that will be secured by his primary residence as not so
secured.
Although section 163(a) of the Code allows a deduction for all
interest paid or accrued within the taxable year on indebtedness,
section 163(h)(1) denies to individuals a deduction for personal
interest. However, section 163(h)(2)(D) exempts qualified residence
interest from the definition of personal interest. Section 163(h)(3)
(A) defines qualified residence interest, in part, as any interest
paid or accrued during the taxable year on home equity indebtedness
with respect to any qualified residence of the taxpayer. Section 163(h)
(3)(C) provides, generally, that home equity indebtedness is
indebtedness, other than acquisition indebtedness, secured by a
qualified residence, not to exceed (1) the fair market value of the
residence reduced by acquisition indebtedness, or (2) certain
specified dollar amounts.
With respect to taxpayers other than corporations, section 163(d) of
the Code provides a deduction for investment interest to the extent
the deduction does not exceed net investment income for the taxable
year. Section 163(d)(3)(A) defines investment interest as any interest
allowable as a deduction under chapter 1 of the Internal Revenue Code
that is paid or accrued on indebtedness properly allocable to property
held for investment. Although section 163(d)(3)(B)(i) states that
investment interest shall not include any qualified residence
interest, section 1.163-10T(o)(5) of the temporary Income Tax
Regulations allows a taxpayer to elect to treat any debt secured by a
qualified residence as not secured by the qualified residence. The
election shall be effective for the taxable year for which the
election is made and for all subsequent taxable years unless revoked
with the consent of the Commissioner.
If A makes the election described in 1.163-10T(o)(5) of the
regulations, no part of the interest paid on the debt to which the
election relates will be qualified residence interest. The interest
paid by A on the mortgage will be investment interest if the mortgage
proceeds is property held for investment.
Section 163(d)(4)(B) of the Code provides that the term "investment
income" includes gross income from property held for investment.
Section 163(d)(5)(A) provides, in part, that the term "property held
for investment" includes any property that produces income of a type
described in section 469(e)(1). Section 469(e)(1) describes certain
types of income, including gross income from interest. Accordingly,
the mortgage proceeds loaned by A to X is property held for
investment.
Therefore, for the reasons set forth above, and if A makes a valid
election under section 1.163-10T(o)(5) of the regulations that remains
in effect:
(1) The interest income received by A from X is investment income
under section 163(d)(4)(B) of the Code and should be reported by A on
Schedule B of Form 1040.
(2) A may treat the interest paid to the bank on the mortgage as
interest on indebtedness properly allocable to property held for
investment, under section 163(d)(3)(A).
(3) A may deduct the interest paid to the bank subject to the
investment interest limitations of section 163(d).
This ruling is directed only to the taxpayer who requested it. Section
6110(j)(3) of the Internal Revenue Code provides that it may not be
used or cited as precedent.
No opinion is expressed as to the federal tax consequences of the
transaction described above under any other provision of the Code.
A copy of this ruling should be attached to A's tax return for the
taxable year in which the transaction covered by this ruling is
consummated. We are enclosing a copy for that purpose.
Sincerely,
Assistant Chief Counsel
(Income Tax & Accounting)
Robert A. Berkovsky
Chief, Branch 2
Enclosure:
Copy for section 6110 purposes
This document may not be used or cited as precedent. Section 6110(j)
(3) of the Internal Revenue Code.
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RAY PLUMB, JR., AND JACQUELYN PLUMB, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
97 T.C. No. 44, 97 T.C. 632, 1991 WL 260735 (U.S.Tax Ct.), Tax Ct.
Rep. (CCH) 47,802, Tax Ct. Rep. Dec. (P-H) 97.44
Docket No. 25344-89.
Filed December 12, 1991.
Ts sustained net operating losses (NOLs) and alternative minimum tax
NOLs in 1984 and 1985. In each of their tax returns for those years,
they stated "Taxpayers elect to forego [sic] the carryback period for
the REGULAR NOL in accordance with sec. 172(b)(3)(C) and will carry
forward this NOL." Ts filed applications for the tentative refunds
resulting from the carryback of their alternative minimum tax NOLs
from 1984 and 1985 to 1983. Ts did not seek any refunds relating to
the carryback of the regular NOLs they sustained in 1984 and 1985.
HELD, the regular and alternative tax net operating loss deductions
are governed by a single carryback period, to which only a single
election made under sec. 172(b)(3)(C) [now sec. 172(b)(3)] may apply.
HELD FURTHER, Ts effectively communicated their intent to make an
election which was unavailable to them, and which was therefore
invalid. Accordingly, they are entitled, indeed required, to carry
back their alternative minimum tax NOLs before carrying them forward,
but at the same time they are similarly required to carry back their
regular NOLs prior to carrying them forward. Sec. 172(b)(2).
[*632] Bruce Locke, Lawrence Sherlock, and L. Don Knight, for the
petitioners.
M. Kathryn Bellis, for the respondent.
[`33] OPINION
RAUM, JUDGE:
The Commissioner determined a deficiency in petitioners' income tax
for their 1983 taxable year in the amount of $311,657. At the time
petitioners filed the petition herein, they resided in Houston, Texas.
This case was submitted on a stipulation of facts and exhibits.
Petitioners attempted in their 1984 and 1985 returns to make an
election under section 172(b)(3)(C) [now 172(b)(3)] of the Code [FN1]
to relinquish the carryback period for only the REGULAR net operating
losses sustained in those years. The deficiency rests upon the
Commissioner's refusal to permit petitioners to carry back the
alternative minimum tax net operating losses. The issues for decision
may be formulated in terms of (1) whether the section 172(b)(3)(C)
election relates to a single carryback period applicable to both the
regular tax and the alternative minimum tax, rather than to two
carryback periods, so that an effective election thereunder would of
necessity preclude any carryback of net operating losses of both
types, and (2) whether, if there was only a single carryback period
applicable to both types of net operating losses, the attempted
limited election here was ineffective, so that petitioners would
therefore be entitled, indeed required, to carry back their
alternative minimum tax net operating losses but would also be
required to carry back their regular net operating losses prior to
carrying them forward.
Petitioners timely filed an income tax return for 1983 on which they
reported liability for the alternative minimum tax in the amount of
$403,862. In 1984, petitioners sustained a net operating loss (NOL) of
$544,066 and an alternative minimum tax NOL of $541,343. Petitioners'
timely filed tax return for 1984 contained the statement that
"Taxpayers elect to forego [sic] the carryback period for the REGULAR
NOL in accordance with section 172(b)(3)(C) and will carry forward
this NOL."
On April 24, 1985, the Commissioner received from petitioners a copy
of Form 1045, entitled "Application for Tentative Refund." This form
showed the computations [*634] underlying the alternative minimum tax
NOL of $541,343 sustained by petitioners in 1984. It also indicated
that the carryback of the 1984 alternative minimum tax NOL to 1983
would entitle petitioners to a refund of $108,269 for 1983. There is
no dispute that they received a refund in this amount. Petitioners did
not seek a refund relating to a carryback of the regular NOL. Instead,
they carried this NOL over to 1985 and claimed it as a deduction for
that year.
In 1985, petitioners sustained a net operating loss of $1,021,804 and
an alternative minimum tax net operating loss of $1,016,940 as
indicated by their timely filed income tax return for that year. Their
1985 return contained the statement that "Taxpayers elect to forego
[sic] the carryback period for the REGULAR NOL in accordance with
section 172(b)(3)(C) and will carry forward this NOL to subsequent
years." Petitioners applied for a tentative refund of $203,388 based
on the carryback of the 1985 alternative minimum tax NOL to their 1983
taxable year. There is no dispute that they received a refund in this
amount. Petitioners did not seek a refund relating to a carryback of
their regular NOL. Instead, they carried this loss over to 1986 and
claimed it as a deduction in that year. [FN2]
The Commissioner subsequently determined that petitioners' "1984 and
1985 alternative minimum tax net operating losses are not allowed in
computation of 1983's alternative minimum tax because elections to
relinquish each of the carrybacks were made in accordance with
Internal Revenue Code section 172(b)(3)(C)." He therefore determined a
deficiency of $311,657 in petitioners' 1983 tax, which was equal to
the sum of the two refunds petitioners had previously received in
respect of that year.
At issue is the effect of petitioners' attempt under section 172(b)(3)
(C) to relinquish the entire carryback period with respect to their
regular NOL for the taxable year while at the same time preserving the
right to carry back the alternative minimum tax NOL for the same year.
The case involves the interplay between the section 172 NOL carryback
and carryover provisions and the section 55 alternative minimum tax.
In considering the problem, it may be helpful to examine briefly the
history of sections 172 and 55.
The deductions for net operating losses were introduced into our
revenue law in 1939 for carryovers and in 1942 for carrybacks. [FN3]
These provisions have been amended from time to time, both before and
after being incorporated into the 1954 Code as section 172. Among the
amendments, both the carryback and carryover periods have been
lengthened. As applicable to the taxable period herein, the carryback
period was 3 years and the carryover period was 15 years. Sec. 172(b)
(1)(A) and (B). Pertinent portions of section 172 as they apply to
this taxable period are set forth in the margin. [FN4]
[*636] Section 172(a) grants a net operating loss deduction for a
taxable year in an amount equal to the sum of the NOL carryovers and
carrybacks to that year. Section 172(b)(2) establishes the manner in
which NOLs are carried backward and forward from the year in which
they were incurred. In general, the NOL is required to be carried back
to the earliest available year of the carryback period, and then (to
the extent not absorbed) to be carried over successively to the next
year or years all the way through the remainder of the carryback
period and the full carryover period until completely absorbed. [FN5]
In terms of the present case, the taxable year is 1983, and we are
here concerned with carrybacks to 1983 from 1984 and 1985.
A taxpayer may elect to relinquish the carryback period with respect
to the loss sustained in a given year. Sec. 172(b)(3)(C). If the
taxpayer so elects, he does not carry back the net operating loss
sustained in that year to any year in the carryback period, and no
part of such loss is allowed as a deduction in any year in that
period. Accordingly, no part of the net operating loss is absorbed by
taxable income in the carryback period. The entire NOL is instead
carried forward to the earliest year in the carryover period. Sec.
172(b)(2). An election under section 172(b)(3)(C) is irrevocable, and
applies to all of the carryback years relating to the loss year for
which the election is made. Sec. 172(b)(3)(C).
Section 55 imposes an alternative minimum tax (AMT) on noncorporate
taxpayers. It did not come into our law until 1978, when it was added
to the Code by the Revenue Act of 1978, Pub. L. 95-600, sec. 421, 92
Stat. 2871. Nothing therein dealt with alternative minimum tax NOLs.
It was [*637] not until 1982 that section 55 was amended to provide
for carrybacks and carryovers of alternative minimum tax NOLs. See Tax
Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248,
sec. 201, 96 Stat. 411. Pertinent provisions of section 55 as thus
amended by TEFRA are set forth in the margin. [FN6]
As applicable to the taxable period before us, section 55(a) provides
that the alternative minimum tax is equal to 20 percent of so much of
the "alternative minimum taxable income" as exceeds an exemption
amount, less the regular tax for the year. It is at this point that
section 55 interacts with section 172, because section 55(b) defines
alternative minimum taxable income as adjusted gross income
(determined without regard to the section 172 deduction) as modified
in several respects, one of which involves the "alternative tax net
operating loss deduction."
[*638] Section 55(d)(1) states that "The term 'alternative tax net
operating loss deduction' means the net operating loss deduction
allowable for the taxable year under section 172," subject to the
exceptions contained in section 55(d)(1)(A) and (B). This definition
thus requires that the amount of the alternative minimum tax NOL
deduction for a particular taxable year must equal the amount of the
regular NOL deduction for that year, except to the extent that
subparagraphs (A) and (B) of section 55(d)(1) require a difference
between the two amounts. Neither of these provisions, however, states
or implies that a separate carryback period exists with respect to the
alternative minimum tax NOL. Indeed, subparagraphs (A) and (B) of
section 55(d)(1) do not relate in any way to the existence or length
of the carryback period, or to the section 172(b)(3)(C) election to
relinquish such a period. [FN7] We find no basis for according
different treatment to an alternative minimum tax NOL than to a
regular NOL with respect to the election provided by section 172(b)(3)
(C). We hold that the general rule contained in section 55(d)(1)
requires that an effective election under section 172(b)(3)(C) must
apply to both types of net operating losses.
Section 172(b)(3)(C) speaks in terms of "relinquish[ing] the entire
carryback period with respect to a net operating loss. It does not
mention either a REGULAR net operating loss or an ALTERNATIVE MINIMUM
tax net operating loss." It is concerned simply with relinquishing the
entire carryback period, without in any way distinguishing between a
regular NOL and an alternative minimum tax NOL. Certainly, nothing in
section 172(b)(3)(C) suggests that it provides for two elections. The
statute deals with but a single carryback period of 3 years. An
effective election under section 172(b)(3)(C) must of necessity relate
to that carryback period, and would preclude any carryback whether it
be the regular NOL or the alternative minimum tax NOL. Had Congress
intended to make available two elections, with [*639] such potentially
disparate results, one would certainly have expected that it would
have explicitly so stated in the 1982 legislation, which for the first
time permitted carrybacks and carryovers of alternative minimum tax
NOLs. In the absence of any such clear expression of legislative
intention in so complex a field, we hold that there is but a single
election contemplated by section 172(b)(3)(C), and that an effective
election made thereunder must be applicable to both the regular NOL
and the alternative minimum tax NOL. To the extent that the taxpayer
has attempted to limit the election merely to the regular NOL, the
election may be invalid -- a matter discussed shortly hereinafter --
and not only would the carryback sought by petitioners for their
alternative minimum tax NOL be permissible, as they contend, but the
regular NOL would also have to be carried back before it could be
carried forward.
A statement made in the legislative history of the Tax Reform Act of
1986, Pub. L. 99-514, 100 Stat. 2085, confirms our conclusion that
only one carryback period exists. The conference report relating to
that act stated that "It is clarified that an election under section
172(b)(3)(C) to relinquish the carryback period applies both for
regular tax and for minimum tax purposes." H. Rept. 99-841 (Conf.)
(1986), 1986-3 C.B. (Vol. 4), 262. We recognize of course, as
contended by petitioners, that this statement could be interpreted
differently. Thus, they argue that the statement can be read as an
attempt by the conference committee to clarify that the section 172(b)
(3)(C) election could be made for the alternative minimum tax NOL as
well as the regular NOL. However, in view of the language used by the
committee, we think that such interpretation is rather strained. We
adhere to our conclusion that the election under section 172(b)(3)(C)
governs both types of taxes.
Petitioners rely on the following example contained in the legislative
history of TEFRA, S. Rept. 97-494, 111-112 (1982):
if in year one a taxpayer has $20,000 of income and $35,000 of losses,
of which $10,000 are preference items, the minimum tax net operating
loss for the year is $5,000. Thus, in any subsequent (or prior) year a
$5,000 net operating loss deduction will be allowed to reduce income
subject to the minimum tax.
Assume that in year two, the taxpayer has $20,000 of minimum taxable
income (without regard to the net operating loss deduction) and [*640]
$20,000 of preferences. The taxpayer will be allowed to reduce his
minimum taxable income to $15,000 by the $5,000 net operating loss
deduction. The net operating loss deduction for purposes of the
regular tax will not be affected by this computation (i.e. the
taxpayer will have a loss carryover of $15,000 from year 1 to be used
under the regular tax in subsequent years).
Petitioners claim that
This example illustrates the distinctness between the regular NOL and
the AMT NOL and the fact that an AMT NOL may be used in one year
without affecting the use of the regular NOL in subsequent years. A
necessary corollary of this relationship is that an AMT NOL may be
carried back to past taxable years while the regular NOL is carried
forward to future years.
The quoted example does not support petitioners' contention. The
example demonstrates only that alternative minimum tax NOL carrybacks
are deducted from and absorbed by alternative minimum taxable income,
while regular NOL carrybacks are deducted from and absorbed by taxable
income. The example does not refer to the carryback period, or to the
election to relinquish such period under section 172(b)(3)(C). It
provides no support for petitioners' position that a separate
carryback period is provided with respect to an alternative minimum
tax NOL.
Having decided that only one net operating loss carryback period
existed, and that an election to waive such carryback period would
necessarily apply for both regular and alternative minimum tax
purposes, it now remains for us to decide whether the actions taken by
petitioners constituted an election to waive the carryback period. For
the reasons subsequently stated, we hold that petitioners did not make
a valid election to waive the carryback period.
Several courts, including this one, have held in various other
contexts that a taxpayer who attempts to make an election that is not
legally available to him will be treated as having made no election,
and accordingly may be allowed to make another election as though the
original election had not been made. E.g. Mamula v. Commissioner, 346
F.2d 1016 (9th Cir. 1965), revg. 41 T.C. 572 (1964); Silver Queen
Motel v. Commissioner, 55 T.C. 1101 (1971); Maid-Rite Steak Co. v.
United States, 643 F. Supp. 1162 (M.D. Pa. 1986). Petitioners here,
however, do not seek to make [*641] another election. Instead, they
argue, (1) that if we hold that only one carryback period exists for
both regular and alternative minimum tax NOLs, then their attempted
election under section 172(b)(3)(C) was invalid, and (2) that this
invalid election could not have affected their right, indeed their
obligation (under section 172(b)(2)), to carry back both regular and
alternative minimum tax net operating losses from 1984 and 1985 to
1983 prior to carrying them forward. We agree with petitioners.
Petitioners 1984 and 1985 tax returns each contained only one
statement purporting to be an election. That statement was "Taxpayers
elect to forego [sic] the carryback period for the REGULAR NOL in
accordance with section 172(b)(3)(C) and will carry forward this NOL."
The use and underlining of the word "regular" is significant in
establishing that petitioners intended to make an election that was
unavailable to them. Cf. Young v. Commissioner, 783 F.2d 1201, 1206
(5th Cir. 1986), affg. 83 T.C. 831 (1984). Furthermore, shortly after
filing their tax returns, they filed requests for tentative refunds
relating only to the carryback of their alternative minimum tax net
operating losses from 1984 and 1985 to 1983. Such requests were
entirely inconsistent with the only permissible elections under
section 172(b)(3)(C), which, as we have held above, would have
required petitioners to relinquish the carryback period applicable to
both types of NOLs.
The Commissioner cites several cases in support of his position, the
strongest of which would appear to be an estate tax case, Rosenfield
v. United States, 156 F. Supp. 780 (E.D. Pa. 1957), affd. per curiam
254 F.2d 940 (3d Cir. 1958). In Rosenfield, the attorney for the
estate checked the box marked "Yes" in answering the question whether
the estate chose to have the alternative valuation date apply for
purposes of valuing the assets for estate tax purposes. The attorney
mistakenly believed that by making this election, the estate would be
allowed to select either the date of death or the alternative
valuation date for each asset independently. The estate tax return
reflected the attorney's confusion, since some assets were valued as
of the date of death, while others were valued as of the alternative
valuation date. The District Court held that the estate's [*642]
election would be valid in the absence of evidence that the estate did
not intend to make the election, despite the fact that the estate tax
return reflected an erroneous view of the nature of the election.
Rosenfield v. United States, supra at 782-783.
While Rosenfield may appear to be analogous to this case, it is
distinguishable. In this case, the elections for 1984 and 1985
consisted of explicit statements made by petitioners on their returns
for those years, and both such statements contained the underlined
word "regular." Thus, the very statements by which petitioners
attempted to make the section 172(b)(3)(C) election made clear their
intent to make a limited election that was unavailable to them. In
Rosenfield, by contrast, the election was made by checking a "Yes" box
rather than a "No" box. The information that revealed the taxpayer's
intent to make an unavailable election did not appear in the statement
by which the election was made, but only in other parts of the return.
The Rosenfield court assigned a much greater significance to the fact
that the "Yes" box was checked than to the inconsistent treatment of
some of the estate's assets on the return, i.e., as though no election
had been made. See Rosenfield v. United States, supra at 782-783.
Here, petitioners made an explicit statement in an attempt to make an
election that was not open to them, in contrast to the election made
in Rosenfield by checking the "Yes" box -- an election that was open
to the taxpayer.
The Commissioner misplaces his reliance on the legislative intent
behind section 6411, which governs, among other things, tentative
refunds stemming from net operating loss carrybacks. It may be true,
as argued by the Commissioner, that only a cursory inspection of the
refund application is possible, given the 90-day period within which
the Commissioner must issue or deny the request for a refund. See sec.
6411(b); S. Rept. 1357, 78th Cong., 2d Sess. (1944), 1945 C.B. 580,
582-583; sec. 1.6411-1(a), Income Tax Regs. But the issuance of a
refund under section 6411 does not prevent the Commissioner from
subsequently determining a deficiency during the period normally
allowed under section 6501 et seq. The time limits imposed on the
Commissioner by the tentative refund procedure therefore did not
interfere [*643] with his ability ultimately to discover that
petitioners intended to make an unavailable election. Those time
limits are irrelevant here.
Having determined that various other contentions made by the parties
do not merit discussion,
Decision will be entered under Rule 155.
FN1 All section references are to the Internal Revenue Code as amended
and in effect for the years in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
FN2 On their 1986 tax return, petitioners stated that they "elect to
forego [sic] the carryback period for net operating losses in
accordance with sec. 172(b)(3)(C) and will carry them forward to
subsequent periods." In 1987, petitioners sustained a net operating
loss and an alternative minimum tax net operating loss and carried
both NOLs back to 1986.
FN3 The carryover provisions were brought into the law as sec. 122 of
the 1939 Code, shortly after the adoption of that code. Revenue Act of
1939, ch. 247, sec. 211, 53 Stat. 867. The carryback provisions were
added in 1942 by an amendment to sec. 122 of the 1939 Code. Revenue
Act of 1942, ch. 619, sec. 153, 56 Stat. 847.
FN4 SEC. 172. NET OPERATING LOSS DEDUCTION.
(a) Deduction Allowed. -- There shall be allowed as a deduction for
the taxable year an amount equal to the aggregate of (1) the net
operating loss carryovers to such year, plus (2) the net operating
loss carrybacks to such year. For purposes of this subtitle, the term
"net operating loss deduction" means the deduction allowed by this
subsection.
(b) Net Operating Loss Carrybacks and Carryovers. --
(1) Years to which loss may be carried. --
(A) Except as provided * * * [in other subparagraphs], a net operating
loss for any taxable year shall be a net operating loss carryback to
each of the 3 taxable years preceding the taxable year of such loss.
(B) * * * Except as provided * * * [in other subparagraphs], a net
operating loss for any taxable year ending after December 31, 1975,
shall be a net operating loss carryover to each of the 15 taxable
years following the taxable year of such loss.
(2) Amount of carrybacks and carryovers. -- Except as provided in
subsection (g), the entire amount of the net operating loss for any
taxable year (hereinafter in this section referred to as the "loss
year") shall be carried to the earliest of the taxable years to which
(by reason of paragraph (1)) such loss may be carried. The portion of
such loss which shall be carried to each of the other taxable years
shall be the excess, if any, of the amount of such loss over the sum
of the taxable income for each of the prior taxable years to which
such loss may be carried. For purposes of the preceding sentence, the
taxable income for any such prior taxable year shall be computed --
(A) with the modifications specified in subsection (d) other than
paragraphs (1), (4), and (5) thereof; and
(B) by determining the amount of the net operating loss deduction --
(i) without regard to the net operating loss for the loss year or for
any taxable year thereafter, * * *
and the taxable income so computed shall not be considered to be less
than zero. * * *
(3) Special Rules.--
* * *
(C) Any taxpayer entitled to a carryback period under paragraph (1)
may elect to relinquish the entire carryback period with respect to a
net operating loss for any taxable year ending after December 31,
1975. Such election shall be made in such manner as may be prescribed
by the Secretary, and shall be made by the due date (including
extensions of time) for filing the taxpayer's return for the taxable
year of the net operating loss for which the election is to be in
effect. Such election, once made for any taxable year, shall be
irrevocable for that taxable year.
FN5 The amount absorbed in each year to which the NOL is carried
is not necessarily the amount of the NOL that was used as a deduction
in each such year. Sec. 172(b)(2) provides that after being carried to
the earliest available year, the portion of the NOL remaining to be
"carried to each of the other taxable years shall be the excess, if
any, of the amount of such loss over the sum of the taxable income for
each of the prior years to which such loss may be carried." Moreover,
the "taxable income" for any such prior year is to be computed with
certain modifications. Unless we deem it appropriate to be more
specific, when we refer to the amount of the NOL as being absorbed in
a particular year, we do so for convenience as a shorthand expression
for the amount thus extinguished for that year pursuant to sec. 172(b)
(2), rather than the amount that was actually used as the NOL
deduction or part thereof for that year.
FN6 SEC. 55. ALTERNATIVE MINIMUM TAX FOR TAXPAYERS OTHER THAN
CORPORATIONS.
(a) Tax Imposed. -- In the case of a taxpayer other than a
corporation, there is imposed (in addition to any other tax imposed by
this subtitle) a tax equal to the excess (if any) of --
(1) an amount equal to 20 percent of so much of the alternative
minimum taxable income as exceeds the exemption amount, over
(2) the regular tax for the taxable year.
(b) Alternative Minimum Taxable Income. -- For purposes of this title,
the term "alternative minimum taxable income" means the adjusted gross
income (determined without regard to the deduction allowed by section
172) of the taxpayer for the taxable year --
(1) reduced by the sum of --
(A) the alternative tax net operating loss deduction, plus
(B) the alternative tax itemized deductions, plus
(C) any amount included in income under section 87 or 667, and
(2) increased by the amount of items of tax preference.
* * *
(d) Alternative Tax Net Operating Loss Deduction Defined. -- For
purposes of this section --
(1) In general. -- The term "alternative tax net operating loss
deduction" means the net operating loss deduction allowable for the
taxable year under section 172, except that in determining the amount
of such deduction --
(A) in the case of taxable years beginning after December 31, 1982,
section 172(b)(2) shall be applied by substituting "alternative
minimum taxable income" for "taxable income" each place it appears,
and
(B) the net operating loss (within the meaning of section 172(c)) for
any loss year shall be adjusted as provided in paragraph (2).
(2) Adjustments to net operating loss computation. --
(A) Post-1982 loss years. -- In the case of a loss year beginning
after December 31, 1982, the net operating loss for such year under
section 172(c) shall --
(i) be reduced by the amount of the items of tax preference arising in
such year which are taken into account in computing the net operating
loss, and
(ii) be computed by taking into account only itemized deductions which
are alternative tax itemized deductions for the taxable year and which
are otherwise described in section 172(c).
FN7 Sec. 55(d)(1)(A) causes alternative minimum tax NOLs to be
absorbed by alternative minimum taxable income in the same way that
regular NOLs are absorbed by regular taxable income. See supra note 5.
Sec. 55(d)(1)(B) requires the exclusion of certain deductions and tax
preference items from the computation of an alternative minimum tax
NOL in order to harmonize the alternative minimum tax NOL deduction
with the policies underlying the alternative minimum tax. See S. Rept.
97-494, 110-111 (1982).
google....@spamgourmet.com
Mansell W. BRANUM, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
17 F.3d 805, 73 A.F.T.R.2d 94-1675, 94-1 USTC P 50,163
No. 93-4251.
April 5, 1994.
Following Commissioner of Internal Revenue's disallowance of carryback
of taxpayer's alternative minimum tax net operating loss (NOL),
taxpayer petitioned Tax Court to determine deficiency. The United
States Tax Court, 65 T.C.M. 1715, T.C. Memo 1993-8, 1993 WL 3464,
sustained Commissioner's determination. Taxpayer appealed. The Court
of Appeals, Wisdom, Circuit Judge, held that taxpayer's statement
attached to main return constituted unambiguous, effective election to
relinquish carryback for both his regular NOL and his alternative
minimum tax NOL.
Affirmed.
History
(Showing 9 documents)
PRIOR HISTORY: Branum v. C.I.R., T.C. Memo. 1993-8, 1993 WL 3464, 65
T.C.M. (CCH) 1715, T.C.M. (RIA) 93,008 (U.S.Tax Ct. Jan. 11, 1993)
(No. 18178-90)
Affirmed by: This opinion
SUBSEQUENT HISTORY: Rehearing and Suggestion for Rehearing in Banc
Denied by: Branum v. C.I.R., 58 F.3d 638 (5th Cir. Jun 05, 1995)
(TABLE, NO. 93-4251)
Distinguished by: Powers v. C.I.R., 43 F.3d 172, 75 A.F.T.R.2d 95-650,
95-1 USTC P 50,086 (5th Cir. Jan. 26, 1995) (No. 94-40005, 94-40006,
94-40007), rehearing denied (Apr 13, 1995)
Miller v. C.I.R., 99 F.3d 1042, 78 A.F.T.R.2d 96-7333, 96-2 USTC P
50,614 (11th Cir. Nov. 14, 1996) (No. 95-3040)
[*806] COUNSEL: William P. Bowers, David Allen Miller, Jenken &
Gilchrist, Dallas, TX, for petitioner-appellant.
Abraham N.M. Shashy, Jr., Chief Counsel, IRS, Charles Bricken, Gary R.
Allen, Chief, Appellate Section, Tax Div., Dept. of Justice, Richard
Farber, Washington, DC, for respondent-appellee.
Appeal from a Decision of the United States Tax Court.
JUDGES: Before WISDOM, BARKSDALE, and EMILIO M. GARZA, Circuit Judges.
WISDOM, Circuit Judge:
Appellant Mansel Branum believes that the decision in this case
reflects our failure to administer a fair, simple and efficient tax
system. Where he seeks an understanding and flexible Tax Code, ours
offers him no solace. As we shall explain, his position deserves some
sympathy. The applicable tax law, however, is unbending. Specifically,
Branum seeks relief from the Tax Court's holding that he made an
effective election under section 172(b)(3)(C) of the Internal Revenue
Code for his 1985 tax year when evidence indicated that his intention
was otherwise. That holding is legally unassailable and, as such, must
be affirmed.
I.
The petitioner/appellant, Mansell W. Branum, timely filed his 1985
federal income tax return. For that year, he reported a net [*807]
operating loss ("regular NOL") under section 172 and an alternative
minimum tax net operating loss ("alternative minimum tax NOL") under
section 55 of the Internal Revenue Code. [FN1] Specifically, he
reported a regular NOL of $5,003,451 and an alternative minimum tax
NOL of $4,943,544.
FN1. References to the Tax Code are to the Internal Revenue Code of
1954 (26 U.S.C.) as amended up to 1985 (the tax year in question),
unless otherwise indicated.
Branum attached the following statement to his 1985 return:
Taxpayer, in accordance with I.R.C. section 172(b)(3)(C) hereby elect
[sic ] to carry foreward [sic ] all losses sustained in the calendar
year 1985 and forego [sic ] carry back of such losses to prior years.
Branum asserts that he intended this statement to relinquish the
carryback period for his regular NOL, but not for his alternative
minimum tax NOL. In tax jargon, this is referred to as an attempted
"split election".
In support of that construction, he points to his Form 1045
Application for a Tentative Refund, mailed separately on the same day,
in which he requested a refund based on the carryback of his 1985
alternative minimum tax NOL to 1982. An income averaging statement
attached to that form contained this handwritten directive in the
margin:
Regular NOL not carried back per 172(b)(3)(C) election with 1985
return; AMT [alternative minimum tax] carried back only.
Branum cites this statement as evidence that the first statement--the
one he attached to his main return--reflected his intent to make a
split election.
The Commissioner granted Branum's request for a "tentative" refund of
$972,708, based upon the carryback of Branum's 1985 alternative
minimum tax NOL to 1982. Later, after conducting an audit of Branum's
return, the Commissioner reversed that decision; he disallowed the
carryback of Branum's alternative minimum tax NOL. The Commissioner
reasoned that Branum's initial statement on his 1985 return
constituted an effective election and, thus, relinquished the
carryback period with respect to both his regular NOL and his
alternative minimum tax NOL. Branum, in turn, petitioned the Tax Court
to redetermine the deficiency. [FN2]
FN2. Although several other matters were initially in dispute, this
case involves only the question at hand. All other issues have been
resolved. More, this case was submitted on a stipulation of facts and
exhibits.
The Tax Court sustained the Commissioner's determination. The court
explained that section 172 permits a taxpayer to elect to carryback
both his regular NOL and his alternative minimum tax NOL; a split
election by which he elects to carryback one or the other is not
permissible. Although Branum contends that his failed attempt to make
such a split election renders the entire election ineffective, the Tax
Court found otherwise. The court concluded that Branum's statement
attached to his return constituted an unambiguous election. Hence,
Branum was bound by that statement.
The dispute which forms the basis of this appeal is simple: Branum
contends that, if his attempted split election is not permissible, he
made no election at all. The Commissioner ruled and the Tax Court
held, however, that Branum's statement did not reflect the attempt to
make a split election but, rather, constituted an unambiguous
effective election for both his regular and his alternative minimum
tax NOL's. In so doing, the court refused to consider other evidence
demonstrating his less-than-unequivocal intent to make that election.
Branum urges that we reverse the Tax court on the grounds that the
Commissioner failed to consider the evidence of his true intent. For
the reasons we shall explain directly, we decline to do so.
II.
We review Tax Court decisions in the same manner in which we review
civil actions decided by the district courts. [FN3] We [*808] examine
findings of fact for clear error, while we examine conclusions of law
de novo. [FN4] The Tax Court's holding that Branum made an effective
election is a conclusion of law and, as such, subject to de novo
review.
FN3. Grigg v. Commissioner, 979 F.2d 383, 384 (5th Cir.1992).
FN4. Id.
This case takes us through the intricate labyrinth that is our Tax
Code. In particular, we direct our focus to an individual's ability to
offset his income by his losses. A taxpayer who seeks to recognize an
operating loss must first apply the loss (carry it back) to the three
immediately preceding tax years and carry any remaining loss forward
to the succeeding fifteen tax years. A taxpayer may, however, elect to
relinquish the carryback period for his operating losses under section
172 of the Code. In that instance, the taxpayer may carry forward the
entire loss to offset the income of subsequent tax years without first
carrying it back to the preceding three years. Section 172(b)(3)(C) is
the vehicle for making such an election; it provides, in pertinent
part:
Any taxpayer entitled to a carryback period under paragraph (1) may
elect to relinquish the entire carryback period with respect to a net
operating loss for any taxable year ending after December 31, 1975.
This provision further mandates that the election be made in a manner
prescribed by the Secretary and by the due date of the return.
Moreover, once made, the election is irrevocable.
A taxpayer who does not effectively communicate his unequivocal intent
to relinquish the carryback period for both his regular NOL and his
alternative minimum tax NOL has not made an effective election. This
rule was the subject of some confusion at the time that Branum filed
his 1985 return. The House Conference Report to the Tax Reform Act of
1986 addressed this uncertainty the following year:
It is clarified that an election under Section 172(b)(3)(C) to
relinquish the carryback period applies both for regular tax and for
minimum tax purposes. [FN5]
FN5. House Conference Report No. 99-841, 99th Cong., 2d Sess. II-262
(1986), U.S.Code Cong. & Admin.News, pp. 4075, 4350, 1986-3 C.B. (Vol.
4), 262.
In response to this clarification, the Commissioner published a
revenue ruling which similarly explained that an election under
section 172(b)(3)(C) applies to both regular and alternative minimum
tax NOL's. When faced with the issue in 1991, the Tax Court followed
suit and ruled that a taxpayer may not relinquish the carryback period
for one NOL but not the other. [FN6] As a result, the rule is clear: a
taxpayer who fails to make an effective election is required to
carryback both his regular and his alternative minimum tax NOL.
FN6. Plumb v. Commissioner, 97 T.C. 632, 638, 1991 WL 260735 (1991).
As a starting point, Branum argues that he did all that he believed
was necessary to demonstrate his intent to relinquish the carryback
period with respect to his regular NOL only. He points out that the
clarifications of section 172(b)(3)(C) were promulgated after he filed
his 1985 return. Hence, he seeks an excuse from the strictures of
section 172 because he filed his return within the murky legal context
that those explanations rectified.
We dismiss this "confusion in the law" argument outright. The
complexities of our tax code notwithstanding, a taxpayer cloaked in
ignorance will find no safe haven from liability imposed by law. For
"[w]hile the statutory and financial complexities that our unfair tax
code often involves are irritating, they are certainly not
impossible." [FN7] Consequently, the Tax Court has held that
oversight, poor judgment, and ignorance of the law all fail to
mitigate the binding effect of an otherwise proper election. [FN8] As
we previously have stated: "Were simple misreading of the Tax Code a
valid defense to tax liability, ... we have no doubt that incompetency
in providing [*809] accounting services would carry a premium." [FN9]
FN7. Vogt v. Abish, 663 F.Supp. 321, 327 (S.D.N.Y.1987), judgment
remanded, 842 F.2d 1288, cert. denied, 488 U.S. 891, 109 S.Ct. 225,
102 L.Ed.2d 215 (1988).
FN8. Estate of Stamos v. Commissioner, 55 T.C. 468, 474, 1970 WL 2371
(1970).
FN9. Young v. Commissioner, 783 F.2d 1201, 1204 (5th Cir.1986).
Branum's central contention is that he did not make an effective
election under section 172(b)(3)(C) because he did not communicate his
"unequivocal" wish to relinquish the carryback for both his regular
NOL and his alternative minimum tax NOL. [FN10] This argument has two
components: First, that his initial statement on his return was not an
unambiguous, unequivocal election and, second, that the court should
have considered his subsequent statement filed with his Form 1045 as
further evidence of that ambiguity. We take them in turn.
FN10. Branum's real burden is to cast a shadow of ambiguity over his
intent so that, at the very least, it falls short of "unequivocal".
Branum argues that the statement attached to his main return reflects
his intention to waive the carryback period for his regular NOL only.
Again, Branum stated:
Taxpayer, in accordance with I.R.C. section 172(b)(3)(C) hereby elect
[sic ] to carry foreward [sic ] all losses sustained in the calendar
year 1985 and forego [sic ] carry back of such losses to prior years.
The Tax Court disagreed with that construction. Instead, the court
held that the statement constituted an unambiguous, effective election
under section 172. The court reasoned that the phrases "all losses"
and "such losses" plainly encompass both NOL's. [FN11] Accordingly,
the court perceived no evidence of the petitioner's attempt to make a
split election.
FN11. The appellant's argument suffers from a fatal circularity.
Branum contends that this statement is, by itself, ambiguous. He seeks
to use, however, the subsequent statement on his Form 1045 as evidence
of that ambiguity. The inference logically follows that, without that
subsequent statement, the directive attached to the main return is
clear.
We agree. The statement, on its face, uses broad language that
contradicts Branum's assertion that he intended to make a split
election. Branum nonetheless points to the Plumb case, ostensibly for
the proposition that a taxpayer in these circumstances should be held
to have made no election at all. [FN12]
FN12. In the central holding of that case, the Tax Court held that a
taxpayer could not relinquish the carryback period for his regular NOL
but not his alternative minimum tax NOL. If you waive one, you waive
both.
In Plumb, the taxpayer attached the following statement to his return:
"Taxpayers elect to forego [sic ] the carryback provision for the
regular NOL in accordance with section 172(b)(3)(C) ..." (emphasis in
original). The Plumb court specifically relied on the taxpayer's
unambiguous reference to his "regular" NOL. From that, it was apparent
that the taxpayer did not understand that he could relinquish both or
none. Based upon the taxpayer's statement, clearly intending to make
an impermissible split election, the Plumb court held that the
taxpayer had not made an effective election. [FN13]
FN13. Although the Plumb court did bolster its reasoning with
reference to other information contained within the taxpayer's Form
1045, that information supported the opinion, not the court's ultimate
decision. It is crystal clear from the Tax Court's reasoning that the
use of the word "regular" was dispositive as to the taxpayer's intent.
The statement in the present matter leads to the opposite conclusion.
In this case, Branum stated that he elected to "carry foreward [sic ]
all losses sustained in the calendar year 1985 and forego [sic ] carry
back of such losses to prior years" (emphasis added). These terms
leave no trail of ambiguity; unlike the statement at issue in the
Plumb case, the terms "all losses" and "such losses" indicate that
Branum intended to relinquish the carryback for both NOL's. The Tax
Court got it right when it held that this statement was "sweeping and
unambiguous" and, accordingly, reflected an effective election.
Branum next argues that even if the statement attached to his main
return is not ambiguous, his statement in the margin of the schedule
filed with his Form 1045 reveals his true intention to make an
impermissible split election. The court disregarded this subsequent
statement because it ceased to be relevant in the light of Branum's
unambiguous initial statement attached to his main [*810] return.
Branum charges that the court's failure to consider that subsequent
statement as evidence of his true intent constitutes legal error.
While we are sympathetic with his position, the law is not.
In 1977, the Secretary promulgated temporary regulations implementing
section 172(b)(3)(C). These rules provide, in part, that a statement
describing the election, the period for which it applies, and the
taxpayer's entitlement for making it must be attached to the
taxpayer's main tax return. [FN14] The Tax Court concluded in the
present matter that the original statement attached to the return met
these criteria and constituted an unambiguous statement of election.
[FN15]
FN14. Sec. 7.0(d), Temporary Income Tax Regs., 42 Fed.Reg. 1470 (Jan.
7, 1977).
FN15. It is true that "substantial compliance with regulatory
requirements may suffice when such requirements are procedural and
when the essential statutory purposes have been fulfilled." American
Air Filter v. Commissioner, 81 T.C. 709, 719, 1983 WL 14887 (1983).
Here, the Tax Court held that Branum had literally complied (i.e., his
unambiguous statement of election on the main return), thus obviating
the need to look for other indicia of substantial compliance.
Branum nonetheless urges that the court erred when it failed to
consider, as evidence of his intent, the statement attached to his
Form 1045: "Regular NOL not carried back per 172(b)(3)(C) election
with 1985 return; AMT NOL carried back only." He relies on three cases
for the proposition that the Commissioner and the Tax Court were bound
to consider evidence outside of his main return on the question of his
intent: Young v. Commissioner [FN16], Turney v. Commissioner [FN17],
and Carlstedt Assoc., Inc. v. Commissioner [FN18]. None of these
cases, however, stands for that submission.
FN16. 783 F.2d 1201 (5th Cir.1986), aff'g, 83 T.C. 831, 1984 WL 15635
(1984).
FN17. 56 T.C.Memo. (P-H) 390 (¶ 87,074), 1987 WL 40167 (1987).
FN18. 58 T.C.Memo. (P-H) 112 (¶ 89,027), 1989 WL 871 (1989).
First, Branum asserts that Young stands for the proposition that "the
Commissioner must consider documents filed with the Commissioner
outside of a return for purposes of determining whether the taxpayer
made an effective election". [FN19] That case stands for no such rule
in its holding or dicta. On the contrary, the Court in Young held that
the Commissioner could not be charged with knowledge of information
beyond that which was contained on the return. [FN20]
FN19. Brief for Appellant at 12.
FN20. Young, 783 F.2d at 1206.
The Turney decision is a mildly more helpful case to the appellant.
Branum contends that the Turney court based its holding that a
taxpayer had made a similar election (though under a different
provision) upon statements made outside of the taxpayer's return. It
is true that the court indicated that the evidence demonstrating an
irrevocable intent may come from sources outside the return itself.
[FN21] That proposition does not further Branum's position. The Turney
court never held that the Commissioner must look to evidence outside
of the return, only that evidence of that intent may properly come
from such sources. The court stated:
FN21. Turney, 56 T.C.Memo. (P-H) at 394-95, 1987 WL 40167 at 6-7.
What is required is evidence of an affirmative intent on the
taxpayer's part to make the required election and be bound thereby.
[FN22]
FN22. Id. at 395, 1987 WL 40167 at 6.
In this light, it is plain that Turney doesn't get Branum where he
needs to be. The Turney court had no other basis, short of examining
evidence outside of the return, for ascertaining the taxpayer's
intent. In the matter at hand, that problem doesn't exist. As we have
spelled out, all the "evidence of an affirmative intent" was contained
on Branum's initial statement. Nothing bound the court to look
further.
Last, in the Carlstedt case, the Tax Court held that a taxpayer who
inadvertently attached an unambiguous statement of election to the
return would nonetheless be bound by [*811] that statement. Branum
submits that the court directed the Commissioner to examine documents
filed outside of the return, even though the statement attached to the
return was unambiguous. If Carlstedt really said that, it would be
impressive support for Branum's position. It does not, however.
Rather, the Court in Carlstedt stated unequivocally that any
information beyond the unambiguous statement attached to the return is
"irrelevant to the determination of whether a valid and binding
election was made under section 172(b)(3)(C)". [FN23] The court then
quoted with approval Judge Higginbotham's emphatic statement from our
decision in Young:
FN23. Carlstedt, 58 T.C.Memo. (P-H) at 129, 1989 WL 871 at 21.
[N]ineteen bishops swearing as to the taxpayers' subjective intent
would not carry this argument, because it contends for an irrelevant
fact. [FN24]
FN24. Id. (quoting Young, 783 F.2d at 1206).
If nineteen bishops can't do it, a handwritten notation in the margin
of a tax schedule filed with a subsequent form mailed under separate
cover cannot do it either.
In sum, Branum's reliance on these three cases does him more harm than
good. They do not, under any plausible reading, stand for the
proposition that the Commissioner must look beyond an unambiguous
election attached to the taxpayer's return. While the Commissioner is
free to consider other evidence, nothing requires that he do so.
Branum's subjective intent ultimately is irrelevant. We are concerned
only with the objective manifestation of his intent--here, the
unambiguous statement on his return. We hold that this statement is
sufficiently indicative of the petitioner's unequivocal intent to make
an election. The Tax Court did not err when it refused to consider
Branum's subsequent statement.
As a final word, we acknowledge that we are sympathetic with Branum's
position. The evidence taken as a whole reveals his genuine intention
to make an impermissible split election, just as he contends. The
Commissioner, at least by the audit, knew of Branum's true intent (or
at least his inconsistent statements). [FN25] Although the statement
in the margin of the schedule to Form 1045 was by no means an
election--it merely attempted to characterize the election Branum made
on his regular return--the Commissioner should have known what Branum
really meant.
FN25. At oral argument, the parties engaged in a lively debate over
whether the Internal Revenue Manual requires the Form 1045 to be
stapled to the taxpayer's return when a case file is established.
Although we will not pass on the binding nature of those rules, it
seems certain that the Commissioner knew of Branum's true intent, at
least by the audit. It is a stipulated fact that the Commissioner
reviewed Branum's 1985 return and his Form 1045 on the same day.
Accordingly, while the Tax Court's decision is legally unassailable,
we recognize that it imposes an election on Branum that he did not
wish to make. The law's requirement that the election be "unequivocal"
is evidence that a taxpayer who does not clearly seek this election
should not be forced to suffer it. [FN26] We are without recourse,
under the strictures of the statute, however, to satisfy Branum beyond
these token acknowledgements. [FN27]
FN26. See, e.g., Valdes v. Commissioner, 60 T.C. 910, 914, 1973 WL
2669 (1973) (election must reflect the taxpayer's unequivocal
agreement).
FN27. But See Plato, The Republic Bk. I., 343d (B. Jowett trans.,
Modern Library ed. 1982) ("When there is an income tax, the just man
will pay more and the unjust less on the same amount of income.").
The history of our jurisprudence reflects a particular inflexibility
in the application of the tax laws. The collection of revenue does not
allow for such case-by-case adjudication. We note this because Branum
is not the first, nor will he be the last, taxpayer whose story,
however appealing, did not move the I.R.S. Twenty years ago, our
colleague Judge Goldberg wrote for this Court in United States v.
Second National Bank of North [*812] Miami [FN28]. That case presented
a similar problem and the Court, with equal reticence, similarly
concluded that nothing in the law prevented the I.R.S. from pursuing
its cold course. [FN29] As our resolution in the present matter
mirrors his, we appropriate Judge Goldberg's final statement for our
concluding thought:
FN28. 502 F.2d 535 (5th Cir.1974).
FN29. Id. at 549.
Our federal tax code may appear to operate with a rigidity that makes
its collectors bereft of human pity, conscience, or compassion; its
operation is also an illustration that ours is a government of laws,
not men. [FN30]
FN30. Id.
AFFIRMED.
google....@spamgourmet.com
Bradley C. MILLER and Dianne M. Miller, Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
99 F.3d 1042, 78 A.F.T.R.2d 96-7333, 96-2 USTC P 50,614
No. 95-3040.
Nov. 14, 1996.
Taxpayers sought review of determination of Commissioner of Internal
Revenue disallowing carryback of taxpayers' alternative minimum tax
net operating loss. The United States Tax Court, 104 T.C. 330, No.
7263-93, Gerber, J., entered judgment for Commissioner and taxpayers
appealed. The Court of Appeals, Hill, Senior Circuit Judge, held that
taxpayers did not make unequivocal and unambiguous election to
relinquish their right to carry back their net operating loss and
alternative minimum tax net operating loss and, thus, no election was
made.
Reversed.
[*1042] COUNSEL: Mark A. Brown, Carlton, Fields, Ward, Emmanuel, Smith
& Cutler, Tampa, FL, for Petitioners-Appellants.
Gary R. Allen, Chief, Richard Farber, Thomas J. Clark, Steven W.
Parks, Loiretta C. Argrett, Appellate Section Tax Division, Dept. of
Justice, Washington, DC, for Respondent-Appellee.
Appeal from the Decision of the United States Tax Court.
[*1043] JUDGES: Before BARKETT, Circuit Judge, and DYER and HILL,
Senior Circuit Judges.
HILL, Senior Circuit Judge:
This appeal from the Tax Court involves the issue of whether the
taxpayers' election statement under Internal Revenue Code Section
172(b)(3)(C) [FN1] unequivocally communicated their intent to
relinquish the carryback period for both a net operating loss (NOL)
and an alternative minimum tax net operating loss (AMT NOL). Finding
that it did not, we reverse the decision of the Tax Court.
FN1. In general, an NOL is carried back to each of three preceding
years to offset taxable income (beginning with the earliest year
first).
Then, to the extent that it has not been absorbed, the NOL is carried
forward to each of the next fifteen years. I.R.C. § 172(b)(1), (2). A
taxpayer may irrevocably elect to relinquish his three-year carryback
period. I.R.C. § 172(b)(3)(C). In that case he may use the NOL only by
carrying it forward to offset income in subsequent years. Id.
I.
Bradley C. and Dianne M. Miller filed their 1984 federal income tax
return. They reported a tax liability of zero, and an alternative
minimum tax (AMT) liability of $46,000. The Millers paid this sum to
the Commissioner of Internal Revenue (Commissioner) in a timely
manner. The next year the Millers sustained an NOL of $332,000 and an
AMT NOL of $156,000. An opportunity for personal income tax planning
was presented as, naturally, the Millers wanted to offset both types
of 1985 losses against income to the greatest lawful advantage under
the tax code.
Robert B. Krusoe was the Miller's certified public accountant. In
preparing their 1985 return, Krusoe determined that, if the Millers
carried back their 1985 AMT NOL to 1984, they would be entitled to a
refund of $41,000. He found no such benefit in carrying back their
"regular" NOLs. Krusoe concluded that it would be financially
beneficial to the Millers if they elected to relinquish the carryback
period for "regular" NOLs and carry them over only into future years.
Krusoe then researched whether this could be done legally under the
tax code. [FN2] At the time, there was a dearth of information on the
treatment of AMT NOLs for carryback purposes. Relying on an article in
a respected tax periodical, [FN3] substantiated by the written opinion
of a former IRS employee and colleague, and his own research, Krusoe
filed an election on the Millers' behalf to waive the NOL carryback
period and, in so doing, attempted to "split" their election:
FN2. Krusoe testified that, if his research had shown that the
carryback periods could not be split, he fully intended to carry both
losses back to assure the refund rightfully due the Millers.
FN3. The article stated:
It is unclear whether both a regular NOL and AMT NOL from the same
year must be given the same carryover treatment. For example, it may
be possible to carryback a regular NOL and elect to carry forward an
AMT NOL even though both NOLs originated in the same year. Independent
treatment would seem appropriate in that for 1983, separate treatment
was required due to the fact that an AMT NOL could not be carried back
to a pre-1983 year, but no such limitation applied to a regular tax
NOL.
Gary R. Stout & Earl J. Weiss, "Analysis of the Alternative Minimum
Tax Net Operating Loss: The Second NOL", 61 J.Tax., 418, 422 (December
1984).
In accordance with the Internal Revenue Code Section 172, the
Taxpayers hereby elect to forego the net operating loss carry back
period and will carryforward the net operating loss. (Emphasis added.)
Krusoe testified that it was his intent to waive only the regular NOL
carryback period and not the AMT NOL carryback period. He claims that
was why he chose the singular word "loss" and not its plural,
"losses." Krusoe prepared the election statement by tracking the exact
statutory language of NOLs in the tax code. By so doing, he intended
the term "net operating loss" to mean regular NOLs. He thought it
unnecessary to refer to AMT NOLs at all. [FN4]
FN4. Expert witnesses testified at trial that, in the early 1980's,
the term 'net operating loss' was commonly understood by members of
the tax accounting industry to mean regular NOLs, not AMT NOLs.
Thereafter Krusoe filed an amended 1984 return for the Millers and
carried back their [*1044] AMT NOL. He did not carryback their NOL.
[FN5] The return stated:
FN5. Krusoe's cover letter to the Millers, with their completed 1985
return, stated that, for 1985, they had sustained a "regular net
operating loss of [$332,000] which [had] been elected to be carried
forward ... [and] an alternative minimum tax net operating loss of
[$156,000], which ... [the Millers, with the assistance of Krusoe,
would] carryback after [the] return [was] filed."
The amended return is filed to carryback an alternative minimum
taxable net operating loss in accordance with Internal Revenue Code §
55(d). AMT NOL computations are on page 5 and first carried back to
1983, on page 6, then to 1984 also on page 6.
Subsequently, the Millers received a refund of $41,000 from the
Commissioner.
II.
Hindsight and writing skills were not in Krusoe's favor. In 1986, a
House Conference Report was issued, making it clear that "an election
under section 172(b)(3)(C) to relinquish the carryback period applies
both for regular tax and for minimum tax purposes." 2 H.R.Conf.Rep.
No. 99-841, 99 th Cong., 2d Sess. II-262, 283 (1986), U.S.Code Cong. &
Admin.News 1986, pp. 4075, 4350, 4371. One year later, the
Commissioner issued a revenue ruling stating that the election was
indivisible and could not be split. Rev.Rul. 87-44, 1987-1 C.B. 3. In
addition, in 1991, the Tax Court ruled that NOLs and AMT NOLs could
not be split and carried in different directions. Plumb v.
Commissioner, 97 T.C. 632, 636, 1991 WL 260735 (1991).
Subsequently, in 1993, the Commissioner issued a notice of deficiency
to the Millers, disallowing the carryback of the AMT NOL, and, seeking
the return of the refunded AMT. The Millers filed a petition in the
Tax Court contesting the Commissioner's determination. They argued
that, after Plumb, 97 T.C. at 632, if they were not permitted to split
their carryback periods, then their election was invalid as ambiguous
on its face, and they should be allowed to carryback both their AMT
NOL and their regular NOL.
The Tax Court rejected this contention stating:
... objectively and on its face, when considered in the context of the
election, [the election] does not create ambiguity or show that [the
taxpayers] attempted to carry forward only NOL's computed by the
regular method. The operative language in [the taxpayers'] election
included the phrase "to forego the net operating loss carry back
period." Under the statute, that necessarily would include NOLs and
AMT NOLs.
The Tax Court found that the Millers' election statement unequivocally
and unambiguously communicated an intent to waive the carryback period
for both their NOL and their AMT NOL. It held, as a matter of law,
that the Millers had made an effective election under Code Section
172(b)(3)(C) and were bound by that election. We review the Tax
Court's holding de novo. Powers v. Commissioner, 43 F.3d 172, 175 (5th
Cir.1995); Branum v. Commissioner, 17 F.3d 805, 808 (5th Cir.1994).
III.
While this issue is one of first impression in this circuit, the Fifth
Circuit has considered it twice recently. Powers v. Commissioner, 43 F.
3d 172 (5th Cir.1995); Branum v. Commissioner, 17 F.3d 805 (5th Cir.
1994). In both Branum and Powers, the taxpayers attempted a split
election that was later found to be unavailable to them. The Fifth
Circuit determined that a taxpayer's election to waive the carryback
period under Code Section 172(b)(3)(C) must be unequivocal and
unambiguous to be effective. Powers, 43 F.3d at 176; Branum, 17 F.3d
at 811; see also Young v. Commissioner, 783 F.2d 1201, 1206 (5th Cir.
1986).
In Branum, the taxpayer attempted to file a "split" election notice,
sending NOLs and AMT NOLs in different directions for offset purposes.
Unlike the Millers, however, the Branum taxpayer used the plural word,
"losses," and the phrase, "all losses," in his election statement. 17
F.3d at 806. When it was later determined that a split election was
impermissible, the Branum taxpayer sought to repudiate his election,
as he, like the Millers, benefited from waiving the carryback only as
to his NOLs and not his AMT NOLs. The Fifth Circuit found that he had
waived the carryback periods for both. Id. The [*1045] Branum
taxpayer's use of the plural in his election statement "unequivocally
communicated his intent" to waive both types of losses, id. at 808,
and left no room for even a "shadow of ambiguity." [FN6] Id. at 809 n.
11. This was fatal to his claim. Id. at 809.
FN6. In this case, the Tax Court found that the Millers should not be
permitted to repudiate their own language by showing, what it termed
"a mere shadow of ambiguity."
In Powers, the taxpayer, in his attempt to file a "split" election
notice, used the right subsection of the tax code but the wrong
section number. The Fifth Circuit held the taxpayer's error caused his
election to be ambiguous on its face and fatal to the validity of his
election. Powers, 43 F.3d at 177. The court found that an invalid
election is no election at all and that the Powers taxpayer had not
relinquished the right to carryback his NOLs. [FN7] Id. at 179.
FN7. Here the Tax Court distinguished Powers on the basis that the
Millers had used language that had correctly cited the proper code
section.
Under a de novo review, the same result is in order here. As the
taxpayers in Branum and Powers, the Millers attempted a split election
under Code Section 172(b)(3)(C) that was later determined to be
unavailable to them. Plumb, 97 T.C. at 641. Unlike the Branum election
notice, however, the Miller's notice did not refer to "losses" but to
"loss. [FN8] " Using the Fifth Circuit precedent of Branum and Powers
as guidance, we find the Miller's election to be ambiguous and
equivocal on its face, and hence, invalid. Branum, 17 F.3d at 805;
Powers, 43 F.3d at 175. For purposes of Code Section 172(b)(3)(C),
their invalid election is no election at all. Id. Therefore, the
Millers have not relinquished their right to carryback both their
regular NOLs and their AMT NOLs. Id.
FN8. The Tax Court here found itself "compelled to hold that the
[singular] term "net operating loss" objectively and on its face, when
considered in the context of the election, does not create ambiguity
or show that [the Millers] attempted to carry forward only NOL's
computed by the regular method."
IV.
The decision of the Tax Court is REVERSED.
REVERSED.
google....@spamgourmet.com
Journal of Taxation
Volume 70, Number 4
April, 1989
Personal
Edited by Jacquin D. Bierman, J.D.
*216 PLANNING WITH THE INTEREST TRACING RULES -- DOUBTS REMAIN
Sally M. Jones [FNa]
Electronic Version Copyright 1991 Warren Gorham Lamont
Classification of debt, encumbered by rules for tracing loan proceeds,
continues to have unresolved issues for pass-through entities.
The deductibility of interest expense by an individual depends on the
classification [FN1] of the interest under Section 163(h)(2):
1. Interest on debt that is properly allocable to a trade or business
(other than the trade or business of performing services as an
employee) is fully deductible in computing adjusted gross income.
2. Interest on debt that is properly allocable to investment property
is deductible to the extent of the taxpayer's net investment income;
any disallowed amount of interest expense is carried forward to future
taxable years as investment interest. [FN2] The allowable investment
interest is an itemized deduction.
3. Interest on debt that is incurred in connection with a passive
activity is subject to the passive activity loss limitation rules of
Section 469. The interest expense allowable under Section 469 is
deductible in computing the taxpayer's adjusted gross income. [FN3]
4. Qualified residence interest is fully allowed as an itemized
deduction.
5. Personal interest paid or accrued during the taxable year is
nondeductible. [FN4] Personal interest is a residual category that
includes any type of interest that does not fall into one of the four
categories listed above. [FN5]
The Interest Tracing Rules
Temp. Reg. 1.163-8T governs the classification of interest expense
paid or accrued in years beginning after 1986. Temp. Reg. 1.163-8T(c)
(2)(ii) states that interest expense accruing on a debt for any period
is classified in the same manner as the underlying debt for that
period regardless of when the interest is actually paid.
Debt is classified in accordance with the use of the debt proceeds,
i.e., by "tracing" the borrowed funds to specific expenditures. [FN6]
Taxpayers can maximize their amount of deductible interest expense by
deliberately using borrowed funds for certain expenditures and
maintaining careful records that substantiate the usage.
EXAMPLE: Ms. Clark anticipates making several major expenditures
during the current year. She plans to invest $17,000 in investment
real estate, $13,000 in business equipment for her sole
proprietorship, and $5,000 in a Mediterranean pleasure cruise. She
intends to finance $15,000 of these expenditures from savings
(unborrowed funds) and $20,000 from newly incurred debt.
Ms. Clark should use $5,000 of the unborrowed funds to pay for her
cruise. The remaining $10,000 of unborrowed funds and $7,000 of
borrowed funds should be used to make the real estate investment, and
the remaining $13,000 of the borrowed funds should be used to pay for
the business equipment. Under the tracing rule, $7,000 (35%) of the
debt will be investment debt, while $13,000 (65%) will be business
debt. For the period during which this proportionate classification
applies, 35% of the interest expense will be investment interest
(deductible to the extent of net investment income) and 65% will be
business interest (fully deductible).
In order to achieve this type of desirable result, careful tax
planning before borrowed funds are disbursed is a necessity. Because
of the fungibility of money, there are no economic consequences to
this tax planning -- an individual will certainly be indifferent as to
which dollars are used for any given expenditure. Furthermore, under
Temp. Reg. 1.163-8T(c)(1), the nature of any security or collateral
for debt is irrelevant in determining the classification of the debt
(except in the case of qualified residence indebtednes).
Tax planning with the interest tracing rules also requires an
appreciation of the issues that the rules do not address. The rules
govern only the classification of interest expense, but have no direct
impact on the deductibility of any given classification. The timing of
the interest expense deduction is also a separate issue and will
depend upon the taxpayer's method of accounting and any other
applicable rules, e.g., Sections 461(g) and 267(a)(2). Finally, the
tracing *217 rules presume that specific expenditures have an
identifiable classification. For example, if a taxpayer uses debt
proceeds to purchase land, the tracing rules provide only that the
debt will be classified in the same manner as the land. The rules
offer no insight as to whether the land is investment property,
business property, or personal property to the taxpayer. [FN6.1]
Specific tracing rule applications.
If borrowed funds are disbursed directly to a party providing services
or selling property to the borrower, the funds obviously can be traced
to the specific service or property. The same logic applies if the
taxpayer assumes a debt as part of the consideration paid for services
or property: the debt is traced to such services or property. [FN7] At
the other extreme, if borrowed funds are simply paid in cash to the
borrower, the funds lose their "identity," become commingled with the
taxpayer's other cash, and are presumed under Temp. Reg. 1.163-8T(c)(5)
(ii) to be used for the taxpayer's personal expenditures.
EXAMPLE: On August 12, Mr. King borrowed $1,000 from a friend and
received the funds in cash. He held the cash until September 1, when
he used it to purchase marketable securities. Temp. Reg. 1.163-8T (c)
(5)(i) allows a taxpayer to consider any cash expenditure made within
15 days after receiving a cash payment of borrowed funds as paid from
those funds on the date the funds were received. However, Mr. King's
expenditure for the securities does not fall within this grace period,
and his $1,000 debt must be classified as personal.
Deposited funds.
If borrowed funds are deposited in an account out of which
expenditures are subsequently made, Temp. Reg. 1.163-8T(c)(4) provides
three general operating rules.
1. During the time the borrowed funds (or any portion thereof) are in
the account, the funds are treated as investment property. This is
true even if the account is non-interest bearing.
2. If the account contains both borrowed and unborrowed funds, any
expenditures out of the account are treated as made first out of
borrowed funds to the extent thereof.
3. If the account contains borrowed funds attributable to more than
one debt, any expenditures out of borrowed funds are treated as made
first from the older debt (a FIFO approach).
One exception, in Temp. Reg. 1.163-8T(c)(4)(iii)(C), provides that if
an account consists solely of borrowed funds and accrued interest, a
taxpayer may treat any expenditure as made from the interest to the
extent thereof. Under a second and much more important exception to
the general rules, in Temp. Reg. 1.163-8T(c)(4)(iii)(B), a taxpayer
may treat any expenditure made within 15 days after the deposit of
borrowed funds into an account as made from those funds. [FN8]
EXAMPLE: On November 21, Ms. Barton borrowed $20,000 and deposited the
funds in a savings account containing unborrowed funds of $30,000. On
December 1, she borrowed $8,000 and deposited the funds in the same
account. On December 12, she withdrew $11,000 for use in her business.
On December 31, the account balance (disregarding accrued interest)
was $47,000. Under the general operating rules, the $11,000 withdrawal
represents funds from the November 21 debt. Therefore, this debt is
investment debt from November 21 through December 11. From December 12
through December 31, $9,000 (45%) of the debt continues to be
investment debt, while $11,000 (55%) is business debt. The December 1
debt is investment debt from its inception through December 31.
However, because the $11,000 withdrawal occurred within 15 days of the
deposit of the funds from the December 1 debt, Ms. Barton may treat
the withdrawal as including that $8,000. The remaining $3,000 of the
withdrawal is from the November 21 debt proceeds. In such case, the
December 1 debt is investment debt from December 1 through December 11
and business debt for the rest of the year. The November 21 debt is
investment debt from November 21 through December 11. From December 12
through December 31, $17,000 (85%) of the debt continues to be
investment debt, while $3,000 (15%) is business debt.
Under the general rule in Temp. Reg. 1.163-8T(c)(4)(iii)(A), an
expenditure from an account is made on the date a check is written on
the account (the date appearing on the check in absence of evidence to
the contrary), provided that the check is delivered to the payee
within a reasonable time. In order to simplify application of the
tracing rules, a taxpayer may treat all expenditures of debt proceeds
made during a calendar month as having been made on the later of the
first day of the month or the date on which the debt proceeds were
deposited in the account (Temp. Reg. 1.163-8T(c)(4) (iv)).
Debt repayment and refinancing.
When the proceeds of a single debt are used for a variety of
expenditures the debt may have to be subdivided into different
components (personal, business, investment, etc.) for interest
allocation purposes. When a taxpayer makes a partial repayment on a
debt consisting of different tax components, it is necessary to
determine how such components are affected by the repayment. Temp.
Reg. 1.163-8T(d) provides an operating rule that a partial debt
repayment is applied in the following order against the components of
a debt allocated to:
1. Personal expenditures.
2. Investments or passive activities (other than those described in 3
and 4, below).
3. A passive rental activity in which the taxpayer actively
participates.
4. Former passive activities.
5. Trade or business expenditures. If one of the above components *218
is attributable to more than one expenditure, a repayment applied to
the component is applied to the earliest expenditure.
This operating rule is generally advantageous, in that repayments will
reduce debt in such a manner as to maximize the deductibility of
interest to be paid on the remaining balance. However, the computation
to allocate interest on a debt that is being repaid on an installment
basis will be extremely complicated.
EXAMPLE: In January, Mr. Corbin borrows $90,000 and will make monthly
repayments over four years. He uses $50,000 of the funds in his
business and $40,000 in a passive activity. Each monthly repayment of
principal will first reduce the $40,000 passive activity component of
the debt. Once this component is paid off, subsequent principal
payments will reduce the $50,000 business component of the debt. Thus,
the allocation of the unpaid balance of the debt between its passive
activity component and its business component (and the resulting
interest allocation) will change with every principal repayment. One
obvious planning technique is for Mr. Corbin to create separate debts
for the two different expenditures. By doing so, accounting for the
classification of the debts will be considerably simplified.
If debt is refinanced, Temp. Reg. 1.163-8T(e) provides that the
"replacement debt" will assume the same classification as the original
debt. Similarly, if debt proceeds are used to pay interest or
borrowing costs, the new debt is classified in the same manner as the
debt on which the interest or borrowing costs were paid. [FN9]
EXAMPLE: In 1988, Mr. Land negotiated a $100,000 one-year unsecured
loan with a local bank. He used $30,000 of the borrowed funds in his
business, $50,000 to invest in a limited partnership, and $20,000 to
add a swimming pool to his personal residence. In 1989, he repaid
$35,000 of the loan and refinanced the remaining $65,000 for two years
at a higher interest rate. The $35,000 repayment is applied to the
$20,000 personal portion of the original debt and to $15,000 of the
passive activity debt. Consequently, the replacement debt consists of
$35,000 of passive activity debt and $30,000 of business debt.
Reclassification of existing debt.
When debt proceeds are used to purchase an asset, the original
classification of the debt depends upon the nature of the asset
(personal, investment, etc.). Temp. Reg. 1.163-8T (j)(i) provides that
the debt will be reclassified if the nature of the asset changes, or
if the asset is sold and the proceeds used for a different
expenditure.
EXAMPLE: In 1988, Ms. Perkins borrowed $12,000 and used the funds to
purchase an asset used exclusively in her business. For 1988, the debt
is business debt and the interest paid on the debt is fully
deductible. In 1989, Ms. Perkins sells the asset for $10,000 cash to
be used to buy Christmas gifts for Ms. Perkins' family. The personal
use of the sale proceeds causes $10,000 of the 1988 debt to be
reclassified as personal. Presumably, the $2,000 balance of the debt
remains business debt under Temp. Reg. 1.163-8T(j) (ii). If Ms.
Perkins converts the asset to personal use in 1989 rather than selling
it, reclassification of the debt is also required. If the value of the
asset is less than the principal amount of the debt, an amount of debt
limited to the value is reclassified as personal debt. If the value
equals or exceeds the principal amount of the debt, the entire debt is
reclassified.
The presumption that the original classification of a debt is not
changed to the extent that proceeds from the sale of the originally
acquired asset are less than the debt has extremely important
implications.
EXAMPLE: During 1987, Mr. May borrowed $65,000 to acquire an interest
in a passive activity. In 1989, he abandoned the interest, and by
doing so was able to deduct his suspended passive activity losses from
earlier years against other sources of income under Section 469(g)(1).
No cash was generated by the abandonment, and Mr. May remains
personally liable for repayment of the $65,000 debt.
There are several possible classifications for Mr. May's debt
subsequent to the abandonment of the passive activity interest. The
presumption in the Regulations that the original classification is
changed *219 only to the extent that sales proceeds are used for
another expenditure suggests that the debt should continue to be
classified as passive activity debt. However, the abandonment of the
activity triggered the full deductibility of the suspended losses
(including prior years' interest on the debt). [FN10] This result
suggests that the debt should be reclassified as a business debt, on
the theory that the triggering mechanism of Section 469 (g)(1) should
extend to the debt so that deductibility of future interest payments
is consistent with the deductibility of interest paid in prior years.
An alternative theory is that the disposition of the partnership
interest caused a retroactive reclassification of the asset itself
from passive to business activity.
A third possibility is that the debt should be classified as personal.
While this possibility seems both illogical and inequitable, it is
suggested by a literal reading of Section 163(h)(2), which labels any
current interest expense that is not paid on business, investment, or
passive activity debt and is not qualified residence interest as
personal interest by default.
EXAMPLE: In 1988, Mr. Burns borrows $25,000 to purchase stock in a C
corporation. In January 1990, the shareholders make a Subchapter S
election, effective for the corporate taxable year beginning on
1/1/90. During 1988 and 1989, Mr. Burns' debt is investment debt.
[FN11] However, for 1990 the asset (corporate stock) acquired with the
debt proceeds has changed from an investment asset to an interest in a
pass-through entity. To the extent of the value of the stock on
1/1/90, the debt should be reclassified based on the rules applicable
to debt incurred to acquire an interest in pass-through entity
(discussed below). Presumably, the debt will continue to be classified
as investment to the extent the amount of the debt exceeds the value
of the stock.
Qualified Residence Interest
TRA '86 made "qualified residence interest" fully deductible; RA 87
completely revised the definition of that term for 1988 and subsequent
taxable years. Under Section 163(h) (3)(A), qualified residence
interest is interest paid or accrued during the taxable year on
acquisition debt or home equity debt. To qualify as acquisition debt,
debt must meet three independent requirements:
1. It must be secured by a qualified residence.
2. It must have been incurred to acquire, construct, or substantially
improve a qualified residence.
3. The aggregate amount of the debt must not exceed $1 million
($500,000 for a married taxpayer filing a separate return).
Debt secured by a qualified residence that was incurred to refinance
acquisition debt is acquisition debt to the extent of the refinanced
amount of acquisition debt. [FN12]
The definition of qualified residence was not changed by RA '87. A
qualified residence includes the taxpayer's principal residence
(within the meaning of Section 1034) and one other dwelling selected
by the taxpayer which is used by the taxpayer as a residence (within
the meaning of Section 280A(d)(1)). [FN13]
In determining whether the requirements for acquisition debt are met,
it is neither necessary that the residence was qualified on the date
the debt was incurred nor that the debt was initially secured by the
residence. Similarly, it is not necessary that the residence was
qualified when acquired, constructed or improved. [FN14]
EXAMPLE: In 1988, Ms. Lewis incurred a $70,000 debt to purchase a
residence that she intended to hold as rent property. The debt was not
originally secured by the residence. In March 1989, Ms. Lewis secured
the debt with the residence; on June 1 she converts the property to
her principal residence. Subsequent to 1/1/89, the debt qualifies as
acquisition debt.
For debt to qualify as home equity debt, it must be secured by a
qualified residence. The aggregate amount of home equity debt is
limited to the excess of the value of the qualified residence over the
total amount of acquisition debt with respect to such residence. In
addition, Section 163 (h)(3)(C) limits the aggregate amount of the
debt to $100,000 ($50,000 for a married taxpayer filing a separate
return).
EXAMPLE: Mr. and Mrs. Stone own a personal residence with a current
market value of $300,000. The Stones incurred a $200,000 mortgage to
acquire their home; this debt is secured by the residence. In the
current year, the Stones use the residence as security to obtain a
$60,000 second mortgage; $35,000 of the proceeds are used to remodel
the kitchen, while $25,000 is used in Mr. Stone's business. Because
$35,000 of the proceeds from the second mortgage were used to
substantially improve a qualified residence, this portion of the debt
is acquisition debt. The $25,000 balance of the mortgage meets all of
the requirements for home equity debt. Therefore, the Stones may
deduct the entire amount of interest payable on both the first and
second mortgages.
In this case, the taxpayer might prefer that the $25,000 of the
mortgage representing home equity debt be classified as business debt
under the general tracing rules. The interest paid on such business
debt would be deductible in computing Mr. Stone's net business
earnings subject to self-employment tax. Temp. Reg. 1.163-10T(0)(5)
allows a taxpayer to elect to treat any debt secured by a qualified
residence as not secured by the qualified residence. If this language
encompasses an election to treat a specified portion of a debt as
unsecured, Mr. Stone can use the election to shift the interest
deduction attributable to the home equity debt from Schedule A to
Schedule C.
Tax planning for qualified residence interest.
The most important distinction between acquisition debt and home
equity debt is the requirement that the proceeds of the former be used
for a specific purpose, i.e., the acquisition, construction, or
substantial improvement of a qualified residence. In Notice 88-74, IRB
1988-27, 27, the IRS has announced that this requirement is satisfied
to the extent that the proceeds of the debt can be traced (within the
meaning of Temp. Reg. 1.163-8T) to the acquisition, construction, or
improvement of a residence.
*220 In most straight-forward acquisitions, the proceeds of the
purchaser's home mortgage will be disbursed directly to the seller at
closing. In these cases, the tracing rules create the required nexus
between debt proceeds and acquisition. In other situations, the
tracing rules may fail to qualify a mortgage as acquisition debt. In
anticipation of such situations, Notice 88-74 promises that
forthcoming Regulations will provide an alternative to the tracing
rules. This alternative (consisting of three "90-day rules") enables a
taxpayer to establish that debt was incurred to acquire, construct, or
improve a residence even if the debt proceeds cannot be directly
traced to such purpose.
EXAMPLE: On 2/23/89 Mr. and Mrs. Boyd bought a vacation home with
$195,000 of unborrowed funds. Late in April they took out a $150,000
mortgage secured by the home. They used the borrowed funds to pay off
some debts for their children. Because the Boyds did not use the funds
to acquire the home, the mortgage cannot qualify as acquisition debt
under the tracing rules.
Fortunately, the first 90-day rule provides that debt secured by a
residence will be considered acquisition debt to the extent of
expenditures to acquire the residence made within 90 days before or
after the debt is incurred. Under this rule, the debt is acquisition
debt to the Boyds. If the Boyds had delayed taking out the mortgage
until after May 24, however, the mortgage would not be acquisition
debt under either the tracing rules or the 90-day rule. However,
$100,000 of the mortgage would meet the requirements for home equity
debt, and the interest attributable to that portion of the mortgage
would be fully deductible.
EXAMPLE: The Wilsons decided to construct a new principal residence on
land they inherited from a parent. On 6/2/88, they obtained a $200,000
loan secured by certain investment assets, and immediately began using
the funds for construction. The home is completed on 8/31/89 at a
total cost of $205,000. On 9/19/89 the Wilsons obtained a $150,000
mortgage secured by the home and used the funds to pay down the
earlier loan.
Because the 1988 construction loan is not secured by a qualified
residence, it is not acquisition debt. The nature of this loan must be
determined under the general tracing rules, and because the proceeds
were used to construct a personal residence, the loan is personal in
nature. The Wilsons could have taken advantage of the rule in Temp.
Reg. 1.163-10T(p)(5) that a residence under construction (including
the land) is considered a qualified residence during the 24 months
prior to occupancy as a qualified residence. The Wilsons' residence
was completed (and presumably occupied) just 15 months after the
construction loan was incurred. If the Wilsons had secured the
construction loan with the land, it would have met the requirements
for acquisition debt.
Under the general tracing rules, the proceeds of the $150,000
permanent mortgage were used to pay down a personal debt and cannot be
traced to the construction of the Wilsons' residence. However, the
second 90-day rule provides that debt incurred no later than 90 days
after completion of construction or substantial improvement may
qualify as acquisition debt, but only to the extent of expenditures
for construction or improvement made within the period beginning 24
months prior to completion and ending on the date the debt is
incurred. The Wilsons' mortgage was incurred just 19 days after
completion, and does not exceed the $205,000 of expenditures made
during the 15-month construction period. Thus, the mortgage obtained
on 9/19/89 is acquisition debt.
EXAMPLE: Alice Bryan began construction of a personal residence on
11/20/88. By April 1991 she has spent $330,000 of unborrowed funds on
the home, and estimates that substantial additional funds will be
necessary to finance the project through to completion. On 4/1/91 she
obtains a $500,000 mortgage secured by the property, and uses $180,000
of the proceeds to complete construction by October 1991 (total cost
of $510,000).
The third 90-day rule provides that debt incurred prior to completion
of the construction or substantial improvement of a qualified
residence may be acquisition debt to the extent of expenditures for
construction or improvement made no more than 24 months before the
debt is incurred. To apply this rule, Alice must determine what amount
of the $330,000 was expended between 4/1/89 and 4/1/91. This amount
plus the $180,000 proceeds of the mortgage actually expended (and
traceable) to complete the home represent acquisition debt. The
balance of the mortgage (up to $100,000) meets the requirements for
home equity debt.
Notice 88-74 states that whether a residence or an improvement is
complete depends upon all the facts and circumstances. It also
provides that debt is incurred on the date the proceeds *221 are
disbursed to or for the benefit of the taxpayer (generally the loan
closing date). A taxpayer may consider a debt as having been incurred
on the date that a written loan application is made, but only to the
extent that the debt proceeds are actually disbursed within a
reasonable time after approval of the application; a disbursement
within 30 days of approval will be reasonable. If a written
application is made to incur a debt within any of the time periods
required by the 90-day rules and the application is rejected,
forthcoming Regulations will allow a reasonable extension of the time
period in which to make a new application.
Finally, Notice 88-74 promises Regulations providing that debt
incurred to acquire the interest of a spouse or former spouse in a
residence, incident to divorce or legal separation, will be
acquisition debt. Such a classification will be independent of the
treatment of the transaction under Section 1041, which generally
characterizes such a transaction as a gift from the transferor
(seller) to the transferee (purchaser).
Acquisition of Interests in Pass-Through Entities
The tracing rules of Temp. Reg. 1.163-8T do not explain how to
allocate interest on debt incurred to acquire an interest in a
partnership or S corporation. [FN15] However, in Notice 88-20, IRB
1988-9, 5, the Service provides temporary guidance for such
situations. The Notice only applies to taxable years ending before
1988, and warns that forthcoming Regulations may provide different
rules for interest expense incurred in subsequent years, regardless of
when the debt was incurred.
EXAMPLE: In January 1988, Mr. Crump borrows $45,000 to purchase a 25%
general interest in a calendar-year partnership. During the year, Mr.
Crump materially participates in the partnership business. At the end
of 1988 the partnership owns business assets with a net book value of
$400,000 and marketable securities with a net book value of $200,000.
Mr. Crump believes that the business assets are substantially
appreciated in value, and that the partnership has unrecorded
goodwill. The market value of the securities is $190,000.
In order for Mr. Crump to classify the 1988 interest accruing on the
$45,000 debt, he must first classify the debt. Notice 88-20 states
that the debt should be allocated to the assets of the partnership
using "any reasonable method" such as a pro rata allocation based on
net FMV, net book value, or net adjusted tax basis. In Mr. Crump's
case, an allocation based on net book value at the partnership's year
end would result in $30,000 of the debt (and the related interest
expense) classified as business, and $15,000 classified as investment.
[FN16] However, the value of the business assets may be significantly
greater than their book value, while the investment assets are worth
less than book value. Given these facts, an allocation based on net
FMV would result in a larger amount of the debt classified as
business.
Mr. Crump's situation raises the issue of when the relative mix of
partnership assets should be determined. Assume that the partnership
acquired its marketable securities in 1987 and sold them in late
December 1988, immediately using the proceeds to acquire business
property. Even though the securities were owned by the partnership for
essentially all of 1988, the year-end balance sheet of the partnership
would reflect only business assets. Is it reasonable to classify Mr.
Crump's debt as solely business debt, based upon the partnership's
year-end assets?
EXAMPLE: In 1988, Mr. Green borrows $20,000 to make a capital
contribution to a partnership in exchange for which he receives a 3%
limited partnership interest. He is given no information as to the
composition of the partnership's assets, but receives a Form K-1
showing an allocation of $3,600 business income, $470 interest income,
$1,600 investment interest expense, and $9,500 capital gain from the
sale of investment land.
Notice 88-20 states that debt proceeds used to make a capital
contribution to a pass-through entity should be allocated "using any
reasonable method." But in this case, Mr. Green has no information
about either the assets owned by the partnership or any specific
expenditures of the partnership. The only practical solution seems to
be an allocation based upon the types of net income reported on the
Form K-1. The K-1 reports total income of $11,970, consisting of
passive activity income of $3,600 and net investment income of $8,370.
Thus $6,015 of the debt (3,600/11,970 x $20,000) could be classified
as passive activity debt and $13,985 (8,370/11,970 x $20,000) could be
classified as investment debt.
This allocation method becomes more difficult to defend if the facts
are changed. Assume that Mr. Green's Form K-1 shows a $3,600 business
loss, rather than business income. With these facts, the K-1 shows a
net passive activity loss and a net investment gain. Is it reasonable
to allocate the debt based upon reported items of gain only, so that
the entire debt in this case is investment debt?
Debt Incurred by a Pass-Through Entity
Temp. Reg. 1.163-8T fails to address the issue of allocation of
interest on debt incurred by a partnership or S corporation when the
proceeds are distributed to the partners or shareholders. [FN17]
Notice 88-20 also provides temporary guidance for this situation.
EXAMPLE: During 1988, Mercer Partnership borrowed $50,000 which was
distributed to a general partner, Sloan, to reduce his interest in
partnership capital and profits. Before the distribution, Sloan had a
40% interest; after the distribution his interest is 20%. Mercer's
only activity is a restaurant business.
The proceeds of the $50,000 partnership debt are traceable to the
distribution *222 to Mr. Sloan. However, Notice 88-20 provides that
the partnership may elect to allocate the debt proceeds to the various
partnership expenditures other than the distribution to the partner to
which the proceeds can be traced. In this case, the entire debt would
be classified as business debt.
The partnership also may allocate 20% of the debt (Sloan's share of
the debt) to the distribution to Sloan. As a result, 20% of the
interest expense on the debt should be reported as a separate
deduction labeled "interest expense allocated to debt-financed
distributions" on Sloan's K-1. Sloan must classify this interest
expense by tracing the funds distributed to him to a specific use. The
remaining 80% of the partnership debt should be allocated using any
reasonable method, presumably to the partnership's restaurant
business. [FN18]
Conclusion
The Temporary Regulations and the various pronouncements by the IRS
represent a good faith effort to help individuals faced with the task
of classifying their interest expense for tax purposes. In spite of
the length and complexity of the Temporary Regulations, there are many
unresolved issues for which no substantial authority exists. Until
such time as administrative or judicial authority is provided,
taxpayers and their advisors must approach tax planning under the
interest tracing rules with considerable uncertainty.
[FNa] SALLY M. JONES, CPA, Ph.D., is professor of accounting at the
Graduate School of Business, University of Texas at Austin. She has
previously written for THE JOURNAL.
[FN1] Specific limitations on deductibility may modify the basic rules
that apply to these classes, e.g., Section 265(a)(2).
[FN2] Sections 163(d)(1) and (2). The disallowance of investment
interest in excess of net investment income is phased in through 1991
under Section 163(d)(6).
[FN3] Deductible passive activity interest expense is generically
business interest. The deduction should be reported as a separate line
item on Schedule E, Form 1040, and identified as "passive interest,"
followed by the name of the pass-through entity (partnership or S
corporation) to which the interest expense relates. Notice 88-37, IRB
1988-15, 8.
[FN4] Section 163(h)(1). The disallowance of any deduction for
personal interest is phased in through 1991. For example, for 1988,
40% of personal interest may be claimed as an itemized deduction.
Section 163(h)(5).
[FN5] Section 163(h)(2)(E) excludes interest expense attributable to
Federal estate taxes, the payment of which is deferred under Sections
6163, 6166, or 6166A from the residual category of personal interest.
Such interest expense is fully allowed as an itemized deduction.
[FN6] Temp. Reg. 1.163-8T(c)(1). If interest is properly accrued on a
debt before funds are disbursed, the debt is classified as investment
debt for such period. Temp. Reg. 1.163-8T(c)(6)(iv).
[FN6.1] S. Rep't No. 100-445, 100th Cong., 2d Sess. (1988), indicates
that Congress is not entirely happy with the interest tracing rules.
Discussing Section 163, it suggests that Treasury consider rules
relating to the securing of property to mitigate some of the
complexities of tracing, for example, interest on a loan secured by
personal use property could be considered personal interest; interest
on a loan secured by investment assets could be considered investment
interest. Whether Treasury decides to respond to this gentle hint
remains to be seen.
[FN7] Temp. Regs. 1.163-8T(c)(3)(i) and (ii).
[FN8] Temp. Reg. 1.163-8T(n)(2) provides that the 15-day safe harbor
periods for both cash expenditures and account withdrawals are
extended to 90 days for expenditures made before 8/4/87. Notice 88-20,
IRB 1988-9, 5, states that Regulations will extend the safe harbor
periods to 30 days before and after debt proceeds are received in cash
or deposited in an account. This extension will apply to debt proceeds
received before 1988.
[FN9] Temp. Regs. 1.163-8T(c)(6)(ii) and (iii). In situations in which
accrued interest charged on a debt is compounded at regular intervals,
the allocation of interest accruing on compounded interest becomes
incredibly complicated. See Temp. Reg. 1.163-8T(c)(2)(iii), Example
(2).
[FN10] Abandonment of a passive activity is treated as a fully taxable
disposition within the meaning of Section 469(g)(1). Staff of the
Joint Committee on Taxation, General Explanation of the Tax Reform Act
of 1986, at 222.
[FN11] If a shareholder has a substantial investment motive in
acquiring corporate stock, the stock is an investment rather than a
business asset. The presumption of investment motive is generally very
difficult for a taxpayer to overcome. See Rev. Rul. 78-94, 1978-1 CB
58, and Miller, 70 TC 448 (1978).
[FN12] Section 163(h)(3)(B). Debt incurred and secured by a qualified
residence on or before 10/13/87 and debt incurred to refinance such
debt is acquisition debt and is not subject to the $1 million
limitation. The amount of any pre-10/13/87 debt reduces the $1 million
limitation allowed for other acquisition debt. Section 163(h)(3)(D).
[FN13] Section 163(h)(4)(A)(i). See also Temp. Reg. 1.163-10T(p).
[FN14] Notice 88-74, IRB 1988-27, 27.
[FN15] Temp. Reg. 1.163-8T(h) is reserved to deal with this topic.
[FN16] The business interest should be reported as a separate line
item on Schedule E, Form 1040, and identified as "business interest,"
followed by the name of the partnership. The investment interest
should be entered on Form 4952 to determine the amount deductible by
Mr. Crump on his Schedule A. Notice 88-37, supra note 3.
[FN17] Temp. Reg. 1.163-8T(f) is reserved to deal with this topic at a
future date. See also Banoff, "Maximizing Interest Deductions on
Leveraged Redemptions of Shareholders and Partners," 68 JTAX 216
(April 1988).
[FN18] Notice 88-37, supra note 3.