QUESTION

Tax Memo 

Please read and analyze the following case and write a memo to me. The memo should be no

more then 2 pages, using 12 point font. You don’t need to send me copies of the court cases,

etc.

Lorissa owes Waterbury State Bank $200,000. During the current year, she is unable to

make the required payments on the loan and negotiates the following terms to

extinguish the debt. Lorissa transfers to Waterbury ownership of investment property

with a value of $90,000 and a basis of $55,000, and common stock with a value of

$50,000 and a basis of $70,000. Lorissa also pays Waterbury $5,000 cash, and

Waterbury forgives the remaining amount of

debt. Before the agreement, Lorissa’s

assets are $290,000, and her liabilities are $440,000.

Read and analyze the following authorities and determine how much gross income

Lorissa has from the extinguishment of the debt:

• Sec. 108.
• Reg. Sec. 1.61-12.
• Reg. Sec. 1.1001-2.
• Julian S. Danenberg, 73 T.C. 370 (1979).
• James J. Gehl, 50 F.3d 12 (8th Cir., 1995) affg., 102 T.C. 784(1994).

A couple of suggestions:

–

ReadCode Sec. 108 carefully. It is long. Read it with the tax issue(s) in mind. Some parts of

Sec.108 do not apply to the case.

-There are a few sub-issues that you must address before you can determine the main issue

–how much income Lorissa must recognize from the forgiveness of debt.

-It may be helpful to read some of the RIA analysis in the Federal Tax Coordinator if you have

trouble understanding the issues.

-Spelling, grammar, etc. count.

• 108 Income from discharge of indebtedness.

Internal Revenue Code (RIA)

Internal Revenue Code

• 108 Income from discharge of indebtedness.

(a) Exclusion from gross income.

(1) In general.

Gross income does not include any amount which (but for this subsection) would be includible in gross

income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if-

(A) the discharge occurs in a title 11 case,

(B) the discharge occurs when the taxpayer is insolvent,

(C) the indebtedness discharged is qualified farm indebtedness,

(D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified

real property business indebtedness, or

(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged-

(i) before January 1, 2026, or

(ii) subject to an arrangement that is entered into and evidenced in writing before January 1, 2026.

(2) Coordination of exclusions.

(A) Title 11 exclusion takes precedence. Subparagraphs (B) , (C) , (D) , and (E) of paragraph (1)

shall not apply to a discharge which occurs in a title 11 case.

(B) Insolvency exclusion takes precedence over qualified farm exclusion and qualified real property

business exclusion. Subparagraphs (C) and (D) of paragraph (1) shall not apply to a discharge to

the extent the taxpayer is insolvent.

(C) Principal residence exclusion takes precedence over insolvency exclusion unless elected

otherwise. Paragraph (1)(B) shall not apply to a discharge to which paragraph (1)(E) applies unless

the taxpayer elects to apply paragraph (1)(B) in lieu of paragraph (1)(E).

(3) Insolvency exclusion limited to amount of insolvency.

In the case of a discharge to which paragraph (1)(B) applies, the amount excluded under paragraph

(1)(B) shall not exceed the amount by which the taxpayer is insolvent.

(b) Reduction of tax attributes.

(1) In general.

The amount excluded from gross income under subparagraph (A) , (B) , or (C) of subsection (a)(1)

shall be applied to reduce the tax attributes of the taxpayer as provided in paragraph (2) .

(2) Tax attributes affected; order of reduction.

Except as provided in paragraph (5) , the reduction referred to in paragraph (1) shall be made in the

following tax attributes in the following order:

(A) NOL. Any net operating loss for the taxable year of the discharge, and any net operating loss

carryover to such taxable year.

(B) General business credit. Any carryover to or from the taxable year of a discharge of an amount

for purposes for determining the amount allowable as a credit under section 38 (relating to general

business credit).

(C) Minimum tax credit. The amount of the minimum tax credit available under section 53(b) as of

the beginning of the taxable year immediately following the taxable year of the discharge.

(D) Capital loss carryovers. Any net capital loss for the taxable year of the discharge, and any capital

loss carryover to such taxable year under section 1212 .

(E) Basis reduction.

(i) In general. The basis of the property of the taxpayer.

(ii) Cross reference. For provisions for making the reduction described in clause (i) , see section

1017 .

(F) Passive activity loss and credit carryovers. Any passive activity loss or credit carryover of the

taxpayer under section 469(b) from the taxable year of the discharge.

(G) Foreign tax credit carryovers. Any carryover to or from the taxable year of the discharge for

purposes of determining the amount of the credit allowable under section 27 .

(3) Amount of reduction.

(A) In general. Except as provided in subparagraph (B) , the reductions described in paragraph

(2) shall be one dollar for each dollar excluded by subsection (a) .

(B) Credit carryover reduction. The reductions described in subparagraphs (B) , (C) , and (G) shall

be 33 # cents for each dollar excluded by subsection (a) . The reduction described in

subparagraph (F) in any passive activity credit carryover shall be 33 # cents for each dollar

excluded by subsection (a) .

(4) Ordering rules.

(A) Reductions made after determination of tax for year. The reductions described in paragraph (2)

shall be made after the determination of the tax imposed by this chapter for the taxable year of the

discharge.

(B) Reductions under subparagraph (A) or (D) of paragraph (2) . The reductions described in

subparagraph (A) or (D) of paragraph (2) (as the case may be) shall be made first in the loss for

the taxable year of the discharge and then in the carryovers to such taxable year in the order of the

taxable years from which each such carryover arose.

(C) Reductions under subparagraphs (B) and (G) of paragraph (2) . The reductions described in

subparagraphs (B) and (G) of paragraph (2) shall be made in the order in which carryovers are

taken into account under this chapter for the taxable year of the discharge.

(5) Election to apply reduction first against depreciable property.

(A) In general. The taxpayer may elect to apply any portion of the reduction referred to in paragraph

(1) to the reduction under section 1017 of the basis of the depreciable property of the taxpayer.

(B) Limitation. The amount to which an election under subparagraph (A) applies shall not exceed

the aggregate adjusted bases of the depreciable property held by the taxpayer as of the beginning of

the taxable year following the taxable year in which the discharge occurs.

(C) Other tax attributes not reduced. Paragraph (2) shall not apply to any amount to which an

election under this paragraph applies.

(c) Treatment of discharge of qualified real property business indebtedness.

(1) Basis reduction.

(A) In general. The amount excluded from gross income under subparagraph (D) of subsection

(a)(1) shall be applied to reduce the basis of the depreciable real property of the taxpayer.

(B) Cross reference. For provisions making the reduction described in subparagraph (A) , see

section 1017 .

(2) Limitations.

(A) Indebtedness in excess of value. The amount excluded under subparagraph (D) of

subsection (a)(1) with respect to any qualified real property business indebtedness shall not exceed

the excess (if any) of-

(i) the outstanding principal amount of such indebtedness (immediately before the discharge), over

(ii) the fair market value of the real property described in paragraph (3)(A) (as of such time),

reduced by the outstanding principal amount of any other qualified real property business

indebtedness secured by such property (as of such time).

(B) Overall limitation. The amount excluded under subparagraph (D) of subsection (a)(1) shall not

exceed the aggregate adjusted bases of depreciable real property (determined after any reductions

under subsections (b) and (g) ) held by the taxpayer immediately before the discharge (other than

depreciable real property acquired in contemplation of such discharge).

(3) Qualified real property business indebtedness.

The term “qualified real property business indebtedness” means indebtedness which-

(A) was incurred or assumed by the taxpayer in connection with real property used in a trade or

business and is secured by such real property,

(B) was incurred or assumed before January 1, 1993, or if incurred or assumed on or after such

date, is qualified acquisition indebtedness, and

(C) with respect to which such taxpayer makes an election to have this paragraph apply.

Such term shall not include qualified farm indebtedness. Indebtedness under subparagraph (B) shall

include indebtedness resulting from the refinancing of indebtedness under subparagraph (B) (or this

sentence), but only to the extent it does not exceed the amount of the indebtedness being refinanced.

(4) Qualified acquisition indebtedness.

For purposes of paragraph (3)(B) , the term “qualified acquisition indebtedness” means, with respect

to any real property described in paragraph (3)(A) , indebtedness incurred or assumed to acquire,

construct, reconstruct, or substantially improve such property.

(5) Regulations.

The Secretary shall issue such regulations as are necessary to carry out this subsection , including

regulations preventing the abuse of this subsection through cross-collateralization or other means.

(d) Meaning of terms; special rules relating to certain provisions.

(1) Indebtedness of taxpayer.

For purposes of this section , the term “indebtedness of the taxpayer” means any indebtedness-

(A) for which the taxpayer is liable, or

(B) subject to which the taxpayer holds property.

(2) Title 11 case.

For purposes of this section , the term “title 11 case” means a case under title 11 of the United

States Code (relating to bankruptcy), but only if the taxpayer is under the jurisdiction of the court in

such case and the discharge of indebtedness is granted by the court or is pursuant to a plan approved

by the court.

(3) Insolvent.

For purposes of this section , the term “insolvent” means the excess of liabilities over the fair market

value of assets. With respect to any discharge, whether or not the taxpayer is insolvent, and the

amount by which the taxpayer is insolvent, shall be determined on the basis of the taxpayer’s assets

and liabilities immediately before the discharge.

(4) Repealed.

(5) Depreciable property.

The term “depreciable property” has the same meaning as when used in section 1017 .

(6) Certain provisions to be applied at partner level.

In the case of a partnership, subsections (a) , (b) , (c) and (g) shall be applied at the partner level.

(7) Special rules for S corporation.

(A) Certain provisions to be applied at corporate level. In the case of an S corporation, subsections

(a) , (b) , (c) , and (g) shall be applied at the corporate level, including by not taking into account

under section 1366(a) any amount excluded under subsection (a) of this section .

(B) Reduction in carryover of disallowed losses and deductions. In the case of an S corporation, for

purposes of subparagraph (A) of subsection (b)(2) , any loss or deduction which is disallowed for

the taxable year of the discharge under section 1366(d)(1) shall be treated as a net operating loss

for such taxable year. The preceding sentence shall not apply to any discharge to the extent that

subsection (a)(1)(D) applies to such discharge.

(C) Coordination with basis adjustments under section 1367(b)(2) . For purposes of subsection

(e)(6) , a shareholder’s adjusted basis in indebtedness of an S corporation shall be determined

without regard to any adjustments made under section 1367(b)(2) .

(8) Reductions of tax attributes in title 11 cases of individuals to be made by estate.

In any case under chapter 7 or 11 of title 11 of the United States Code to which section 1398 applies,

for purposes of paragraphs (1) and (5) of subsection (b) the estate (and not the individual) shall be

treated as the taxpayer. The preceding sentence shall not apply for purposes of applying section

1017 to property transferred by the estate to the individual.

(9) Time for making election, etc.

(A) Time. An election under paragraph (5) of subsection (b) or under paragraph (3)(C) of

subsection (c) shall be made on the taxpayer’s return for the taxable year in which the discharge

occurs or at such other time as may be permitted in regulations prescribed by the Secretary.

(B) Revocation only with consent. An election referred to in subparagraph (A) , once made, may be

revoked only with the consent of the Secretary.

(C) Manner. An election referred to in subparagraph (A) shall be made in such manner as the

Secretary may by regulations prescribe.

(10) Cross reference.

For provision that no reduction is to be made in the basis of exempt property of an individual debtor,

see section 1017(c)(1) .

(e) General rules for discharge of indebtedness (including discharges not in title 11 cases or

insolvency).

For purposes of this title-

(1) No other insolvency exception.

Except as otherwise provided in this section , there shall be no insolvency exception from the

general rule that gross income includes income from the discharge of indebtedness.

(2) Income not realized to extent of lost deductions.

No income shall be realized from the discharge of indebtedness to the extent that payment of the

liability would have given rise to a deduction.

(3) Adjustments for unamortized premium and discount.

The amount taken into account with respect to any discharge shall be properly adjusted for

unamortized premium and unamortized discount with respect to the indebtedness discharged.

(4) Acquisition of indebtedness by person related to debtor.

(A) Treated as acquisition by debtor. For purposes of determining income of the debtor from

discharge of indebtedness, to the extent provided in regulations prescribed by the Secretary, the

acquisition of outstanding indebtedness by a person bearing a relationship to the debtor specified in

section 267(b) or 707(b)(1) from a person who does not bear such a relationship to the debtor shall

be treated as the acquisition of such indebtedness by the debtor. Such regulations shall provide for

such adjustments in the treatment of any subsequent transactions involving the indebtedness as may

be appropriate by reason of the application of the preceding sentence.

(B) Members of family. For purposes of this paragraph , sections 267(b) and 707(b)(1) shall be

applied as if section 267(c)(4) provided that the family of an individual consists of the individual’s

spouse, the individual’s children, grandchildren, and parents, and any spouse of the individual’s

children or grandchildren.

(C) Entities under common control treated as related. For purposes of this paragraph , two entities

which are treated as a single employer under subsection (b) or (c) of section 414 shall be treated

as bearing a relationship to each other which is described in section 267(b) .

(5) Purchase-money debt reduction for solvent debtor treated as price reduction.

If-

(A) the debt of a purchaser of property to the seller of such property which arose out of the purchase

of such property is reduced,

(B) such reduction does not occur-

(i) in a title 11 case, or

(ii) when the purchaser is insolvent, and

(C) but for this paragraph , such reduction would be treated as income to the purchaser from the

discharge of indebtedness,

then such reduction shall be treated as a purchase price adjustment.

(6) Indebtedness contributed to capital.

Except as provided in regulations, for purposes of determining income of the debtor from discharge of

indebtedness, if a debtor corporation acquires its indebtedness from a shareholder as a contribution to

capital-

(A) section 118 shall not apply, but

(B) such corporation shall be treated as having satisfied the indebtedness with an amount of money

equal to the shareholder’s adjusted basis in the indebtedness.

(7) Recapture of gain on subsequent sale of stock.

(A) In general. If a creditor acquires stock of a debtor corporation in satisfaction of such corporation’s

indebtedness, for purposes of section 1245 –

(i) such stock (and any other property the basis of which is determined in whole or in part by

reference to the adjusted basis of such stock) shall be treated as section 1245 property,

(ii) the aggregate amount allowed to the creditor-

(I) as deductions under subsection (a) or (b) of section 166 (by reason of the worthlessness or

partial worthlessness of the indebtedness), or

(II) as an ordinary loss on the exchange,

shall be treated as an amount allowed as a deduction for depreciation, and

(iii) an exchange of such stock qualifying under section 354(a) , 355(a) , or 356(a) shall be treated

as an exchange to which section 1245(b)(3) applies.

The amount determined under clause (ii) shall be reduced by the amount (if any) included in the

creditor’s gross income on the exchange.

(B) Special rule for cash basis taxpayers. In the case of any creditor who computes his taxable

income under the cash receipts and disbursements method, proper adjustment shall be made in the

amount taken into account under clause (ii) of subparagraph (A) for any amount which was not

included in the creditor’s gross income but which would have been included in such gross income if

such indebtedness had been satisfied in full.

(C) Stock of parent corporation. For purposes of this paragraph , stock of a corporation in control

(within the meaning of section 368(c) ) of the debtor corporation shall be treated as stock of the

debtor corporation.

(D) Treatment of successor corporation. For purposes of this paragraph , the term “debtor

corporation” includes a successor corporation.

(E) Partnership rule. Under regulations prescribed by the Secretary, rules similar to the rules of the

foregoing subparagraphs of this paragraph shall apply with respect to the indebtedness of a

partnership.

(8) Indebtedness satisfied by corporate stock or partnership interest.

For purposes of determining income of a debtor from discharge of indebtedness, if-

(A) a debtor corporation transfers stock, or

(B) a debtor partnership transfers a capital or profits interest in such partnership,

to a creditor in satisfaction of its recourse or nonrecourse indebtedness, such corporation or

partnership shall be treated as having satisfied the indebtedness with an amount of money equal to

the fair market value of the stock or interest. In the case of any partnership, any discharge of

indebtedness income recognized under this paragraph shall be included in the distributive shares of

taxpayers which were the partners in the partnership immediately before such discharge.

(9) Discharge of indebtedness income not taken into account in determining whether entity

meets REIT qualifications.

Any amount included in gross income by reason of the discharge of indebtedness shall not be taken

into account for purposes of paragraphs (2) and (3) of section 856(c) .

(10) Indebtedness satisfied by issuance of debt instrument.

(A) In general. For purposes of determining income of a debtor from discharge of indebtedness, if a

debtor issues a debt instrument in satisfaction of indebtedness, such debtor shall be treated as

having satisfied the indebtedness with an amount of money equal to the issue price of such debt

instrument.

(B) Issue price. For purposes of subparagraph (A) , the issue price of any debt instrument shall be

determined under sections 1273 and 1274 . For purposes of the preceding sentence, section

1273(b)(4) shall be applied by reducing the stated redemption price of any instrument by the portion

of such stated redemption price which is treated as interest for purposes of this chapter.

(f) Student loans.

(1) In general.

In the case of an individual, gross income does not include any amount which (but for this

subsection ) would be includible in gross income by reason of the discharge (in whole or in part) of

any student loan if such discharge was pursuant to a provision of such loan under which all or part of

the indebtedness of the individual would be discharged if the individual worked for a certain period of

time in certain professions for any of a broad class of employers.

(2) Student loan.

For purposes of this subsection , the term “student loan” means any loan to an individual to assist

the individual in attending an educational organization described in section 170(b)(1)(A)(ii) made by-

(A) the United States, or an instrumentality or agency thereof,

(B) a State, territory, or possession of the United States, or the District of Columbia, or any political

subdivision thereof,

(C) a public benefit corporation-

(i) which is exempt from taxation under section 501(c)(3) ,

(ii) which has assumed control over a State, county, or municipal hospital, and

(iii) whose employees have been deemed to be public employees under State law, or

(D) any educational organization described in section 170(b)(1)(A)(ii) if such loan is made(

1. i) pursuant to an agreement with any entity described in subparagraph (A) , (B) , or (C) under

which the funds from which the loan was made were provided to such educational organization, or

(ii) pursuant to a program of such educational organization which is designed to encourage its

students to serve in occupations with unmet needs or in areas with unmet needs and under which

the services provided by the students (or former students) are for or under the direction of a

governmental unit or an organization described in section 501(c)(3) and exempt from tax under

section 501(a) .

The term “student loan” includes any loan made by an educational organization described in section

170(b)(1)(A)(ii) or by an organization exempt from tax under section 501(a) to refinance a loan to an

individual to assist the individual in attending any such educational organization but only if the

refinancing loan is pursuant to a program of the refinancing organization which is designed as

described in subparagraph (D)(ii) .

(3) Exception for discharges on account of services performed for certain lenders.

Paragraph (1) shall not apply to the discharge of a loan made by an organization described in

paragraph (2)(D) if the discharge is on account of services performed for either such organization.

(4) Payments under National Health Service Corps loan repayment program and certain State

loan repayment programs.

In the case of an individual, gross income shall not include any amount received under section

338B(g) of the Public Health Service Act, under a State program described in section 338I of such Act,

or under any other State loan repayment or loan forgiveness program that is intended to provide for

the increased availability of health care services in underserved or health professional shortage areas

(as determined by such State).

(5) Discharges on account of death or disability.

(A) In general. In the case of an individual, gross income does not include any amount which (but for

this subsection) would be includible in gross income for such taxable year by reasons of the

discharge (in whole or in part) of any loan described in subparagraph (B) after December 31, 2017,

and before January 1, 2026, if such discharge was-

(i) pursuant to subsection (a) or (d) of section 437 of the Higher Education Act of 1965 or the

parallel benefit under part D of title IV of such Act (relating to the repayment of loan liability),

(ii) pursuant to section 464(c)(1)(F) of such Act, or

(iii) otherwise discharged on account of the death or total and permanent disability of the student.

(B) Loans described. A loan is described in this subparagraph if such loan is-

(i) a student loan (as defined in paragraph (2) ), or

(ii) a private education loan (as defined in section 140(7) of the Consumer Credit Protection Act (15

U.S.C. 1650(7))).

(g) Special rules for discharge of qualified farm indebtedness.

(1) Discharge must be by qualified person.

(A) In general. Subparagraph (C) of subsection (a)(1) shall apply only if the discharge is by a

qualified person.

(B) Qualified person. For purposes of subparagraph (A) , the term “qualified person” has the

meaning given to such term by section 49(a)(1)(D)(iv) ; except that such term shall include any

Federal, State, or local government or agency or instrumentality thereof.

(2) Qualified farm indebtedness.

For purposes of this section , indebtedness of a taxpayer shall be treated as qualified farm

indebtedness if-

(A) such indebtedness was incurred directly in connection with the operation by the taxpayer of the

trade or business of farming, and

(B) 50 percent or more of the aggregate gross receipts of the taxpayer for the 3 taxable years

preceding the taxable year in which the discharge of such indebtedness occurs is attributable to the

trade or business of farming.

(3) Amount excluded cannot exceed sum of tax attributes and business and investment

assets.

(A) In general. The amount excluded under subparagraph (C) of subsection (a)(1) shall not

exceed the sum of-

(i) the adjusted tax attributes of the taxpayer, and

(ii) the aggregate adjusted bases of qualified property held by the taxpayer as of the beginning of

the taxable year following the taxable year in which the discharge occurs.

(B) Adjusted tax attributes. For purposes of subparagraph (A) , the term “adjusted tax attributes”

means the sum of the tax attributes described in subparagraphs (A) , (B) , (C) , (D) , (F) , and (G)

of subsection (b)(2) determined by taking into account $3 for each $1 of the attributes described in

subparagraphs (B) , (C) , and (G) of subsection (b)(2) and the attribute described in

subparagraph (F) of subsection (b)(2) to the extent attributable to any passive activity credit

carryover.

(C) Qualified property. For purposes of this paragraph , the term “qualified property” means any

property which is used or is held for use in a trade or business or for the production of income.

(D) Coordination with insolvency exclusion. For purposes of this paragraph , the adjusted basis of

any qualified property and the amount of the adjusted tax attributes shall be determined after any

reduction under subsection (b) by reason of amounts excluded from gross income under

subsection (a)(1)(B) .

(h) Special rules relating to qualified principal residence indebtedness.

(1) Basis reduction.

The amount excluded from gross income by reason of subsection (a)(1)(E) shall be applied to

reduce (but not below zero) the basis of the principal residence of the taxpayer.

(2) Qualified principal residence indebtedness.

For purposes of this section , the term “qualified principal residence indebtedness” means

acquisition indebtedness (within the meaning of section 163(h)(3)(B) , applied by substituting

“$750,000 ( $375,000” for “$1,000,000 ($500,000” in clause (ii) thereof and determined without

regard to the substitution described in section 163(h)(3)(F)(i)(II) ) with respect to the principal

residence of the taxpayer.

(3) Exception for certain discharges not related to taxpayer’s financial conditions.

Subsection (a)(1)(E) shall not apply to the discharge of a loan if the discharge is on account of

services performed for the lender or any other factor not directly related to a decline in the value of the

residence or to the financial condition of the taxpayer.

(4) Ordering rules.

If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal

residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged

as exceeds the amount of the loan (as determined immediately before such discharge) which is not

qualified principal residence indebtedness.

(5) Principal residences.

For purposes of this subsection , the term “principal residence” has the same meaning as when

used in section 121 .

(i) Deferral and ratable inclusion of income arising from business indebtedness discharged by

the reacquisition of a debt instrument.

(1) In general.

At the election of the taxpayer, income from the discharge of indebtedness in connection with the

reacquisition after December 31, 2008, and before January 1, 2011, of an applicable debt instrument

shall be includible in gross income ratably over the 5-taxable-year period beginning with-

(A) in the case of a reacquisition occurring in 2009, the fifth taxable year following the taxable year in

which the reacquisition occurs, and

(B) in the case of a reacquisition occurring in 2010, the fourth taxable year following the taxable year

in which the reacquisition occurs.

(2) Deferral of deduction for original issue discount in debt for debt exchanges.

(A) In general. If, as part of a reacquisition to which paragraph (1) applies, any debt instrument is

issued for the applicable debt instrument being reacquired (or is treated as so issued under

subsection (e)(4) and the regulations thereunder) and there is any original issue discount

determined under subpart A of part V of subchapter P of this chapter with respect to the debt

instrument so issued(

1. i) except as provided in clause (ii) , no deduction otherwise allowable under this chapter shall be

allowed to the issuer of such debt instrument with respect to the portion of such original issue

discount which-

(I) accrues before the 1st taxable year in the 5-taxable-year period in which income from the

discharge of indebtedness attributable to the reacquisition of the debt instrument is includible under

paragraph (1) , and

(II) does not exceed the income from the discharge of indebtedness with respect to the debt

instrument being reacquired, and

(ii) the aggregate amount of deductions disallowed under clause (i) shall be allowed as a

deduction ratably over the 5-taxable-year period described in clause (i)(I).

If the amount of the original issue discount accruing before such 1st taxable year exceeds the income

from the discharge of indebtedness with respect to the applicable debt instrument being reacquired,

the deductions shall be disallowed in the order in which the original issue discount is accrued.

(B) Deemed debt for debt exchanges. For purposes of subparagraph (A) , if any debt instrument is

issued by an issuer and the proceeds of such debt instrument are used directly or indirectly by the

issuer to reacquire an applicable debt instrument of the issuer, the debt instrument so issued shall be

treated as issued for the debt instrument being reacquired. If only a portion of the proceeds from a

debt instrument are so used, the rules of subparagraph (A) shall apply to the portion of any original

issue discount on the newly issued debt instrument which is equal to the portion of the proceeds from

such instrument used to reacquire the outstanding instrument.

(3) Applicable debt instrument.

For purposes of this subsection –

(A) Applicable debt instrument. The term “applicable debt instrument” means any debt instrument

which was issued by-

(i) a C corporation, or

(ii) any other person in connection with the conduct of a trade or business by such person.

(B) Debt instrument. The term “debt instrument” means a bond, debenture, note, certificate, or any

other instrument or contractual arrangement constituting indebtedness (within the meaning of

section 1275(a)(1) ).

(4) Reacquisition.

For purposes of this subsection –

(A) In general. The term “reacquisition” means, with respect to any applicable debt instrument, any

acquisition of the debt instrument by-

(i) the debtor which issued (or is otherwise the obligor under) the debt instrument, or

(ii) a related person to such debtor.

(B) Acquisition. The term “acquisition” shall, with respect to any applicable debt instrument, include

an acquisition of the debt instrument for cash, the exchange of the debt instrument for another debt

instrument (including an exchange resulting from a modification of the debt instrument), the

exchange of the debt instrument for corporate stock or a partnership interest, and the contribution of

the debt instrument to capital. Such term shall also include the complete forgiveness of the

indebtedness by the holder of the debt instrument.

(5) Other definitions and rules.

For purposes of this subsection –

(A) Related person. The determination of whether a person is related to another person shall be

made in the same manner as under subsection (e)(4) .

(B) Election.

(i) In general. An election under this subsection with respect to any applicable debt instrument

shall be made by including with the return of tax imposed by chapter 1 for the taxable year in which

the reacquisition of the debt instrument occurs a statement which-

(I) clearly identifies such instrument, and

(II) includes the amount of income to which paragraph (1) applies and such other information as

the Secretary may prescribe.

(ii) Election irrevocable. Such election, once made, is irrevocable.

(iii) Pass-thru entities. In the case of a partnership, S corporation, or other pass-thru entity, the

election under this subsection shall be made by the partnership, the S corporation, or other entity

involved.

(C) Coordination with other exclusions. If a taxpayer elects to have this subsection apply to an

applicable debt instrument, subparagraphs (A), (B), (C), and (D) of subsection (a)(1) shall not

apply to the income from the discharge of such indebtedness for the taxable year of the election or

any subsequent taxable year.

(D) Acceleration of deferred items.

(i) In general. In the case of the death of the taxpayer, the liquidation or sale of substantially all the

assets of the taxpayer (including in a title 11 or similar case), the cessation of business by the

taxpayer, or similar circumstances, any item of income or deduction which is deferred under this

subsection (and has not previously been taken into account) shall be taken into account in the

taxable year in which such event occurs (or in the case of a title 11 case, the day before the petition

is filed).

(ii) Special rule for pass-thru entities. The rule of clause (i) shall also apply in the case of the sale

or exchange or redemption of an interest in a partnership, S corporation, or other pass-thru entity by

a partner, shareholder, or other person holding an ownership interest in such entity.

(6) Special rule for partnerships.

In the case of a partnership, any income deferred under this subsection shall be allocated to the

partners in the partnership immediately before the discharge in the manner such amounts would have

been included in the distributive shares of such partners under section 704 if such income were

recognized at such time. Any decrease in a partner’s share of partnership liabilities as a result of such

discharge shall not be taken into account for purposes of section 752 at the time of the discharge to

the extent it would cause the partner to recognize gain under section 731 . Any decrease in

partnership liabilities deferred under the preceding sentence shall be taken into account by such

partner at the same time, and to the extent remaining in the same amount, as income deferred under

this subsection is recognized.

(7) Secretarial authority.

The Secretary may prescribe such regulations, rules, or other guidance as may be necessary or

appropriate for purposes of applying this subsection , including-

(A) extending the application of the rules of paragraph (5)(D) to other circumstances where

appropriate,

(B) requiring reporting of the election (and such other information as the Secretary may require) on

returns of tax for subsequent taxable years, and

(C) rules for the application of this subsection to partnerships, S corporations, and other pass-thru

entities, including for the allocation of deferred deductions.

© 2021 Thomson Reuters/Tax & Accounting. All Rights Reserved.

GEHL v. COMM., 75 AFTR 2d 95-1605 (50 F3d 12), Code Sec(s) 61; 108, (CA8), 3/20/1995

American Federal Tax Reports (Prior Years) (RIA)

American Federal Tax Reports

GEHL v. COMM., Cite as 75 AFTR 2d 95-1605 ( 50 F3d 12),

Code Sec(s) 61; 108, (CA8), 3/20/ 1995

James J. GEHL; Laura GEHL, APPELLANTS v. COMMISSIONER of Internal Revenue, APPELLEE.

Case Information:

[pg. 95-1605 ]

Code Sec(s): 61; 108

Court Name: U.S. Court of Appeals, Eighth Circuit,

Docket No.: Docket No. 94-3111,

Date Decided: 3/20/ 1995 .

Prior History: Tax Court, (1994) 102 TC 784 (opinion by Tannenwald, J. ), affirmed.

Tax Year(s): Years 1988, 1989.

Disposition: Decision for Commissioner.

Related Proceedings: Related Proceedings at Gehl v. Commissioner, 102 T.C. 784 (1994)

Cites: 75 AFTR 2d 95-1605, 95-1 USTC P 50191, 50 F3d 12 .

HEADNOTE

1. Gross income-discharge of indebtedness vs. gain. Tax Court properly determined that taxpayers

realized gain from transfer of farmland pursuant to loan restructuring agreement, and that credit assn.’s

loan forgiveness was excluded. Although taxpayers remained insolvent, Code Sec. 108(a)(1)(B) ‘s

insolvency exception only applied to discharge of indebtedness: land transferred by deed in lieu of

foreclosure was sale or exchange under Code Sec. 1001 because it was partial satisfaction of recourse

debt.

Reference(s): ¶ 615.116(12) ; ¶ 1085.01(5) Code Sec. 61 ; Code Sec. 108

OPINION

Appeal from the United States Tax Court

*

Before HANSEN, Circuit Judge, John R. GIBSON, Senior circuit Judge, and BOGUE, ** Senior District

Judge.

Judge: BOGUE, Senior District Judge:

Taxpayers James and Laura Gehl (taxpayers) appeal from an adverse decision in the United States Tax

Court 1 finding deficiencies in their income taxes for 1988 and 1989. For the reasons stated below, we

affirm.

Background

Prior to the events in issue, the taxpayers borrowed money from the Production Credit Association of the

Midlands (PCA). Mortgages on a 218 acre family farm were given to the PCA to secure the recourse

loan. As of December 30, 1988, the taxpayers were insolvent and unable to make the payments on the

loan, which had an outstanding balance of $152,260. The transactions resolving the situation between

the PCA and the taxpayers form the basis of the current dispute.

Pursuant to a restructuring agreement, taxpayers, by deed in lieu of foreclosure, conveyed 60 acres of

the farm land to the PCA on December 30, 1988, in partial satisfaction of the debt. The taxpayers’ basis

in the 60 acres was $14,384 and they were credited with $39,000 towards their loan, the fair market

value of the land. On January 4, 1989, taxpayers conveyed, also by deed in lieu of foreclosure, an

additional 141 acres of the mortgaged farm land to the PCA in partial satisfaction of the debt. Taxpayers’

basis in the 141 acres was $32,000 and the land had a fair market value of $77,725. Taxpayers also

paid $6,123 in cash to the PCA to be applied to their loan. The PCA thereupon forgave the remaining

balance of the taxpayers’ loan, $29,412. Taxpayers were not debtors under the Bankruptcy Code during

1988 or 1989, but were insolvent both before and after the transfers and discharge of indebtedness.

After an audit, the Commissioner of Revenue (Commissioner) determined tax deficiencies of $6,887 for

1988 and $13,643 for 1989 on the theory that the taxpayers had realized a gain on the disposition of

their farmland in the amount by which the fair market value of the land exceeded their basis in the same

at the time of the transfer (gains of $24,616 on the 60 acre conveyance and $45,645 on the con- [pg.

95-1606] veyance of the 141 acre conveyance). 2 The taxpayers petitioned the Tax Court for

redetermination of their tax liability for the years in question contending that any gain they realized upon

the transfer of their property should not be treated as income because they remained insolvent after the

transactions.

The Tax Court found in favor of the Commissioner. In doing so, the court “bifurcated” its analysis of the

transactions, considering the transfers of land and the discharge of the remaining debt separately. The

taxpayers argued that the entire set of transactions should be considered together and treated as

income from the discharge of indebtedness. As such, any income derived would be excluded as the

taxpayers remained insolvent throughout the process. 26 U.S.C. section 108(a)(1). 3 As to the

discharge of indebtedness, the court determined that because the taxpayers remained insolvent after

their debt was discharged, no income would be attributable to that portion of the restructuring

agreement.

On the other hand, the court found the taxpayers to have received a gain includable as gross income

from the transfers of the farm land (determined by the excess of the respective fair market values over

the respective basis). This gain was found to exist despite the continued insolvency in that the gain from

the sale or disposition of land is not income from the discharge of indebtedness. The taxpayers

appealed.

Discussion

[1] We review the Tax Court’s interpretation of law de novo. Jacobson v. Commissioner, 963 F.2d

218, 219 [69 AFTR 2d 92-1232]( 8th Cir. 1992). Discussion of this case properly begins with an

examination of I.R.C. section 61 which defines gross income under the Code. In order to satisfy their

obligation to the PCA, the taxpayers agreed to participate in an arrangement which could potentially give

rise to gross income in two distinct ways. 4 I.R.C. section 61(a)(3) provides that for tax purposes,

gross income includes “gains derived from dealings in property.” Likewise, income is realized pursuant

to I.R.C. section 61(a)(12) for “income from discharge of indebtedness.”

There can be little dispute with respect to Tax Court’s treatment of the $29,412 portion of the debt

forgiven subsequent to the transfers of land and cash. The Commissioner stipulated that under I.R.C.

section 108(a)(1)(B), 5 the so-called “insolvency exception,” the taxpayers did not have to include as

income any part of the indebtedness that the PCA forgave. The $29,412 represented the amount by

which the land and cash transfers fell short of satisfying the outstanding debt. The Tax Court properly

found this amount to be excluded.

Further, the Tax Court’s treatment of the land transfers, irrespective of other portions of the restructuring

agreement, cannot be criticized. Section 1001 governs the determination of gains and losses on the sale

or exchange of property. Section 1001(a) provides that “[t]he gain from the sale or other disposition of

property shall be the excess of the amount realized therefrom over the adjusted basis …” The taxpay-

[pg. 95-1607] ers contend that because the disposition of their land was compulsory and that they had

no discretion with respect to the proceeds, the deeds in lieu of foreclosure are not “sales” for the

purposes of section 1001. We disagree. A transfer of property by deed in lieu of foreclosure constitutes a

“sale or exchange” for federal income tax purposes. Allan v. Commissioner of Revenue, 86 T.C. 655,

659-60, affd. 856 F.2d 1169, 1172 [62 AFTR 2d 88-5715]( 8th Cir. 1988) (citations omitted). The

taxpayers’ transfers by deeds in lieu of foreclosure of their land to the PCA in partial satisfaction of the

recourse debt were properly considered sales or exchanges for purposes of section 1001.

Taxpayers also appear to contend that under their circumstances, there was no “amount realized” under

I.R.C. sections 1001(a-b) and thus, no “gain” from the land transfers as the term is used in

I.R.C. section 61(a)(3). Again, we must disagree. The amount realized from a sale or other disposition of

property includes the amount of liabilities from which the transferor is discharged as a result of the sale

or disposition. Treas. Reg. section 1.1001-2(a)(1). Simply because the taxpayers did not actually

receive any cash proceeds from the land transfers does not mean there was no amount realized. Via the

land transfers, they were given credit toward an outstanding recourse loan to the extent of the land’s fair

market value. This loan had to be paid back. It is clear that the transfers of land employed to satisfy that

end must be treated the same as receiving money from a sale. In this case the land transfers were

properly considered “gains derived from dealings in property” to the extent the fair market value in the

land exceeded the taxpayers’ basis in said land. I.R.C. sections 61(a)(3), 1001(a).

The taxpayers’ primary and fundamental argument in this case is the Tax Court’s refusal to treat the

entire settlement of their loan, including the land transfers, as coming within the scope of I.R.C.

section 108. As previously stated, section 108 and attending Treasury Regulations act to exclude

income from the discharge of indebtedness where the taxpayer thereafter remains insolvent. The

taxpayers take issue with the bifurcated analysis conducted by the Tax Court and contend that, because

of their continued insolvency, section 108 acts to exclude any income derived from the various

transactions absolving their debt to the PCA.

As an initial consideration, the taxpayers read the insolvency exception of section 108 too broadly.

I.R.C. section 61 provides an non-exclusive list of fifteen items which give rise to income for tax

purposes, including income from discharge of indebtedness. Of the numerous potential sources of

income, section 108 grants an exclusion to insolvent taxpayers only as to income from the discharge or

indebtedness. It does not preclude the realization of income from other activities or sources.

While section 108 clearly applied to a portion of the taxpayers’ loan restructuring agreement, the land

transfers were outside the section’s scope and were properly treated independently. See Home Builders

Lumber Co. v. Commissioner, 165 F.2d 1009, 1011 [36 AFTR 730](5th Cir. 1948) (“both the solvent

and the insolvent may receive profits [on a sale] and be liable for the tax thereon”); Estate of Delman v.

Commissioner, 73 T.C. 15, 32 (1979) (“The insolvency exception applies only for cancellation of

indebtedness income. For all other types of income, …, the solvency of the taxpayer is irrelevant.”);

Danenberg v. Commissioner, 73 T.C. 370, 383-86 (1979) (taxpayer’s insolvency did not preclude

him from recognizing a gain or loss on the disposition of property).

There is ample authority to support Tax Court’s bifurcated analysis and substantive decision rendered

with respect to the present land transfers. The Commissioner relies heavily on Treas. Reg. section

1.1001- 2 and example 8 contained therein, which provides:

((a)) Inclusion in amount realized. – (1)***

(2) Discharge of indebtedness. – The amount realized on a sale or other [pg. 95-1608]

disposition of property that secures a recourse liability does not include amounts that are

(or would be if realized and recognized) income from the discharge of indebtedness under

section 61(a)(12).***

(c) Examples***

Example (8). In 1980, F transfers to a creditor an asset with a fair market value of $6,000

and the creditor discharges $7,500 of indebtedness for which F is personally liable. The

amount realized on the disposition of the asset is its fair market value ($6,000). In

addition, F has income from the discharge of indebtedness of $1,500 ($7,500 – $6,000).

We believe the regulation is controlling and serves, along with the Estate of Delman and Danenberg

cases, to provide support for the decision rendered by the Tax Court. 6

Conclusion

For the reasons stated, we affirm the decision of the Tax Court.

* Notice: Eighth Circuit Rule 28A(k) limits citation to unpublished decisions to specific situations.

Please review Rule 28A(k) before citing to an unpublished decision in this circuit.

** The Honorable Andrew W. Bogue, Senior United States District Judge for the Western Division of

the District of South Dakota, sitting by designation.

1 Honorable Theodore Tannenwald Jr.

2 The Commissioner also determined that the taxpayers received income from the discharge of

indebtedness measured by the extent that the PCA’s forgiveness of their loan caused them to become

solvent. This theory has subsequently been abandoned and the Commissioner has stipulated

throughout these proceedings that the taxpayers remained insolvent following the transfers of their

property and the discharge of their debt.

3 Unless otherwise indicated, all statutory references are to the Internal Revenue Code (I.R.C.) of

1986 as amended and in effect during the years in issue.

4 Aside from being part of the restructuring agreement, the taxpayer’s transfer of $6,123 cash to the

PCA has little significance for the purposes of the present appeal.

5 I.R.C. section 108(a)(1)(B) provides that “gross income does not include any amount which (but

for this subsection) would be includable in gross income by reason of the discharge (in whole or in

part) of indebtedness of the taxpayer if …the discharge occurs when the taxpayer is insolvent.” The

regulations further define the exception stating, “income is not realized by a taxpayer by virtue of the

discharge …of his indebtedness as the result of …an agreement among his creditors not

consummated under any provision of the Bankruptcy Act, if immediately thereafter the taxpayer’s

liabilities exceed the value of his assets.” Treas. Reg. section 1.61- 12(b)(1).

6 Despite the technical accuracy of the decision, one wonders about the propriety of the government’s

exhaustive pursuit of this matter in view of the taxpayers’ dire financial situation and continued

insolvency.

© 2021 Thomson Reuters/Tax & Accounting. All Rights Reserved.

DANENBERG, 73 TC 370, 11/27/1979

Tax Court & Board of Tax Appeals (Prior Years) (RIA)

Tax Court & Board of Tax Appeals Reported Decisions DANENBERG v. COMMISSIONER, 73 TC 370

Julian S. Danenberg and Mabel S. Danenberg, Petitionerv. Commissioner of Internal Revenue, Respondent

Case Information:

[pg. 370 ]

HEADNOTE

1.INCOME-Income from discharge of indebtedness-insolvency of debtor. Gain realized on property transferred as part of debt settlement. Insolvent taxpayer sold certain property that bank held as collateral, with proceeds applied to outstanding debt. Other collateral was transferred to bank’s nominee. Gain on sale was taxable even though taxpayer was insolvent following transactions. Gain on property transferred to nominee measured by property’s FMV. Remainder of debt forgiven by bank was tax-exempt cancellation of indebtedness due to taxpayer’s insolvency.

Reference(s): 1980 P-H Fed, ¶7307(5).

2.SUBCHAPTER S ELECTION-Effect on shareholders. Undistributed taxable income was includable in income of shareholder who sold his shares before corp.’s fiscal year ended under agreement effective after close of fiscal year. Insufficient proof that true transfer took place before agreement’s effective date.

Reference(s): 1980 P-H Fed. ¶33,383.

3.ADDITIONS TO TAX AND PENALTIES-Additions for failure to pay tax-negligence penalty-ignorance, negligence, or mistake. Fraud penalty not imposed. Complex facts and issues; businessman wasn’t tax expert.

Reference(s): 1980 P-H Fed. ¶37,299(5).

Syllabus

Official Tax Court Syllabus

1. P was heavily in debt to B. As part of the settlement of such debt, P sold various items of collateral to third parties and transferred his stock in his wholly owned subch. S corporation to a nominee of B. He arranged that the proceeds of such dispositions be forwarded directly to B and applied to reduce his debt. After the liquidation of all P’s collateral, B discharged P from any further liability on his indebtedness. P was insolvent at the time of such discharge. Held: The dispositions of the collateral by P were sales of such collateral, and P realized gain or loss on such sales measured by the difference between the amount realized and his basis in such collateral. The entire amount of such gain or loss is recognizable, subject to the provisions relating to capital gains and losses. Held, further, P did not realize income on the discharge of his remaining debt since he was insolvent at such time.
2. Before the end of the taxable year of his subch. S corporation, M, P executed documents to transfer title to his stock. However, such documents were to take effect after the end of the taxable year of M. Held, P was still the owner of the stock of M on the last day of its taxable year, and therefore, he must include the undistributed taxable income of M in his gross income in accordance with sec. 1373, I.R.C. 1954.
3. The Commissioner determined that part of the underpayment of tax during the year in issue was due to P’s fraud with intent to evade tax within the meaning of sec. 6653(b), I.R.C. 1954. Held, due to the complexity of the facts and issues involved, fraud penalty not imposed.

Counsel

Charles A. Pinney, Jr., and Clifford C. Caldwell, for the petitioners. Charles W. Jeglikowski, for the respondent.

Simpson,Judge:

The Commissioner determined a deficiency of $64,683.60 in the petitioners’ Federal income tax for 1971 and an [pg. 371]addition to tax of $32,341.80 under section 6653(b) of the Internal Revenue Code of 1954. ¹ The Commissioner has conceded certain issues, and the issues remaining for decision are: (1) Whether the petitioners must recognize gain or loss as a result of the disposition of certain of their properties which had been given as collateral for their indebtedness even though they were insolvent at the time of such disposition; (2) whether the petitioner’s transfer of his stock in a subchapter S corporation before the end of the taxable year of such corporation to take effect after the end of such taxable year relieves him of the requirement of section 1373 of including the undistributed taxable income of the corporation in his gross income; and (3) whether any part of the underpayment of tax for the year in issue was due to fraud with the intent to evade tax within the meaning of section 6653(b).

FINDINGS OF FACT

Some of the facts have been stipulated, and those facts are so found.

The petitioners, Julian S. Danenberg and Mabel S. Danenberg, husband and wife, maintained their legal residence in Holtville, Calif., at the time they filed their petition in this case. They filed their joint Federal income tax return for 1971 with the Internal Revenue Service, Fresno, Calif. The petitioners maintained their books and records on the cash method of accounting, and they filed their income tax return on a calendar year basis. Mr. Danenberg will sometimes be referred to as the petitioner.

The petitioner was a farmer in the Imperial Valley of California. During the period from October 1963 through June 1971, he obtained financing for his farming and cattle operations from the United California Bank (UCB or the bank). UCB made loans to the petitioner on real estate, farm equipment, and 37 separate crops, and it held certain property of the petitioner as collateral for the loans. Such collateral included the crops of the petitioner, certain farm equipment, the petitioner’s stock in the Farmer’s Tractor Co., his accounts receivable, an assignment of rents, and all the stock in the Meloland Cattle Co. (Meloland). The bank also held as collateral and had trust deeds for certain [pg. 372]real property owned by the petitioner, including six commercial lots located in El Centro, Calif. (the six lots), improved real estate consisting of an onion shed, a labor camp, and approximately 35 acres of land (the onion shed property), and the petitioner’s residence in El Centro, Calif. None of the collateral held by the bank constituted security for “purchase-money” obligations, and in none of the loans to the petitioner did the bank assign a specific value to any of the items of collateral at the time of making the loan. However, subsequently, the bank did make appraisals of the collateral for the purpose of estimating the amounts that could be realized in the event of a foreclosure. The petitioner and Meloland also executed cross-collateralization and cross-guarantee agreements to support the bank’s extension of credit to him. Meloland provided UCB with a continuing guarantee up to $4 million for the petitioner’s personal debt, and the petitioner provided UCB with a personal guarantee for Meloland’s corporate loans.

Sometime in May 1970, the petitioner met with officials of UCB to discuss his financing with the bank. At that time, UCB informed him that it would no longer finance his farming operations because his accumulated debts were so great that they no longer constituted a bankable loan. At another meeting with the bank officials in July 1970, the petitioner stated that he was forming a new corporation to take over his farming operations, and he proposed that such corporation be allowed to purchase for $150,000 the farm equipment which the bank held as collateral. The new corporation, California Farm Exchange, Inc. (CFE), was subsequently incorporated on August 11, 1970, and was funded by various third parties. The petitioner offered to negotiate with CFE for a lump-sum sale of all the farm equipment so that UCB would get more money than if it sold the equipment on a piece-meal basis at auction. Although the bank considered the purchase price to be reasonable, it was hesitant to accept the petitioner’s proposal because it wanted more information regarding the capitalization of CFE. Subsequently, UCB acquiesced in the proposed sale to CFE, and CFE purchased the farm equipment from the petitioner for $157,500 on October 1, 1970. The bank had not instituted foreclosure proceedings against the farm equipment at the time of such sale to CFE. Under the terms of the sales arrangement, CFE made payments directly to the bank, and the bank applied such proceeds to [pg. 373]reduce the petitioner’s debt. The petitioners reported a gain of $19,506.60 from the sale of the farm equipment on their 1970 income tax return.

In July 1970, the petitioner informed the bank that he was negotiating with seven other creditors to whom he owed approximately $300,200 for the purpose of arranging a settlement of their claims. He proposed to make them an immediate payment of $45,000 and additional payments at later dates. The petitioner informed the bank that such $45,000 would be provided by CFE and that the principals of CFE had agreed to such action. In late September 1970, a loan officer of UCB reviewed the petitioner’s account and estimated that after all the petitioner’s collateral had been liquidated and the proceeds were applied to his account, the bank would have a final loss of $800,000.

In December of 1970, John R. Fitch, a vice president of Associated Desert Newspaper, Inc. (the newspaper), called an official at UCB to inquire about purchasing the six lots for the newspaper. UCB told Mr. Fitch to get in touch with the petitioner, and Mr. Fitch met with the petitioner sometime in early January 1971 to discuss a possible sale agreement. All negotiations regarding the sale of the property were subject to the approval of UCB since it wanted to insure that the selling price of the six lots was reasonable and that it received all monies realized from such sale. The bank also had control over the minimum price at which the lots could be sold. At that time, one of the petitioner’s other creditors, Arizona Agro Chemical, had a lien on the property junior to UCB’s lien. Before the petitioner could complete negotiations with Mr. Fitch, he made an arrangement with such company whereby they released its lien for no consideration. The petitioner and Mr. Fitch eventually agreed on a sales price of $58,500 for the six lots, and the bank considered such amount a reasonable selling price.

On or about January 25, 1971, an escrow account was opened with a title insurance company to carry out the sale of the six lots. On January 28, 1971, UCB executed a notice of default and election to sell the six lots and the onion shed property, and it recorded such notice on February 2, 1971. However, before the bank took any formal action to foreclose on the six lots, the sale arrangement with Mr. Fitch was consummated, and title to the property passed from Mr. and Mrs. Danenberg to the newspaper [pg. 374]on April 30, 1971. The title insurance company paid the proceeds of the sale, consisting of the $58,500 selling price less $960.84 selling costs, directly to UCB. The petitioner’s basis in the six lots was $34,719.76; however, the petitioners did not report any gain from the sale of the six lots on their 1971 income tax return.

On March 24, 1971, the petitioner met with the officials of UCB to discuss the transfer of his interest in Meloland to the bank. The bank regarded the Meloland feedlot as the petitioner’s major asset securing his loans. The petitioner had pledged the stock of Meloland to UCB in 1967, and he delivered stock certificate number 1 and executed a blank stock power to the bank at that time. The petitioner and the officials of UCB agreed that if he transferred his Meloland stock to a nominee of the bank, the bank would release the lien on his residence, would look only to the remaining collateral to satisfy his indebtedness, and would forego any deficiency judgment against him following the liquidation of such collateral.

Meloland was incorporated by the petitioner on November 13, 1962, as a small business corporation (subchapter S corporation) of which the petitioner was the sole stockholder. At the time of the petitioner’s negotiations with the bank in 1971, Meloland was being managed by The Diamond A Cattle Co. (Diamond A) pursuant to an agreement with Diamond A’s predecessor dated September 1, 1967. Diamond A also had an option to purchase 51 percent of the stock of Meloland from the petitioner. However, both the management agreement and option to purchase had a termination date of June 30, 1971.

In a letter dated April 19, 1971, Diamond A informed the petitioner that it would terminate its management contract with Meloland and its option to purchase the Meloland stock on June 30, 1971. When UCB was informed of Diamond A’s intentions, it began to seek a buyer for the Meloland feedlot. Roy H. Mann, an attorney representing the bank, drew up an agreement whereby the petitioner was to transfer his interest in Meloland to a nominee of the bank. In an agreement dated May 26, 1971, the petitioner “sold, assigned and transferred” his stock in Meloland to Rummonds Bros. Ranch (Rummonds), the bank’s nominee, subject to a pledge to the bank. However, the agreement provided that such transfer did not release, discharge, or diminish the liens that the bank had on the petitioner’s other property. On such date, the petitioner also executed an assignment [pg. 375]separate from certificate transferring his stock in Meloland as represented by certificate number 1 to Rummonds, but the assignment contained a statement “This Assignment to be effective July 1, 1971.”

Rummonds was an operating feedlot business at the time the petitioner transferred his Meloland stock to it, and Mr. Mann was its sole shareholder at such time. When Mr. Mann drafted the May 26, 1971, stock transfer agreement, it was his intention that such document was a binding agreement on the petitioner, with an effective date of July 1, 1971. Toward the end of July of that year, Mr. Mann still had not received certain corporate books and documents of Meloland from the petitioner. Consequently, on July 27, 1971, he wrote to the petitioner’s attorney requesting him to send the stock book, minute book, journal ledger, and stock certificates of Meloland. Mr. Mann received stock certificate number 1 sometime in late July 1971, and stock certificate number 2, which transferred the stock of Meloland from the petitioner to Rummonds, was dated July 1, 1971, and was mailed to UCB on August 23, 1971. Mr. Mann received the other requested documents of Meloland sometime in August of that year.

UCB never placed a value on the Meloland stock when it took the stock as collateral for the petitioner’s loans. However, subsequently when the bank decided that it would have to liquidate the petitioner’s collateral, it considered the Meloland stock to be worth the amount that could be realized from the sale of the feedlot. The book value of the land and equipment of Meloland was $627,778 as of June 30, 1970. An appraisal the bank conducted on July 21, 1970, revealed that the physical value of such assets was $694,000 and that the loan value was $550,000. In March 1971, the petitioner estimated that the Meloland feedlot would bring approximately $600,000 in a sale and that the commodities of Meloland would bring $100,000. The balance sheet of Meloland on June 30, 1971, revealed that it had net assets of $704,579, comprised of $579,323 in property, plant, and equipment and of $125,256 in cash and other assets; it had liabilities of $436,031 on such date. Thus, its total shareholder equity was $268,548 on such date.

After the transfer of the Meloland stock to Rummonds, Meloland continued to be liable for the petitioner’s obligations to the bank, and Meloland made subsequent payments to UCB to [pg. 376]fulfill such liability. On February 5, 1973, a vice president at UCB informed the president of Meloland’s successor corporation, Melcatco, that Meloland’s continuing guarantee of $4 million for the petitioner’s debts would be reduced to $500,000 upon their immediate payment of $144,810.27 to UCB. Melcatco paid such amount to UCB, and upon the insistence of the bank, it also agreed not to proceed against the petitioner for any amounts paid under such guarantee. Melcatco later paid $135,000 to UCB on February 11, 1974, and $30,000 on April 22, 1975, under the continuing guarantee of the petitioner’s debts.

In a letter dated May 7, 1971, the bank notified Mrs. Danenberg that a trustee’s sale of the onion shed property was scheduled for June 4, 1971. However, on or about May 28, 1971, an escrow account was opened with a title insurance company for the sale of the onion shed property by the petitioner to CFE. Consequently, the June 4 trustee’s sale was postponed by UCB, as were three other trustee’s sales-one scheduled in July 1971 and two in August 1971. The bank agreed to such postponements in order to allow the petitioner to negotiate the sale of the property to CFE with the expectation that it would receive a larger amount of money to apply against his debt. In connection with such transaction, UCB loaned CFE $75,000 to purchase the onion shed property, and the bank also asked the petitioner to have the principals of CFE provide a continuing guarantee for the loan. The onion shed property was subsequently sold to CFE on September 3, 1971, for $100,000. The proceeds of such sale were paid directly to the bank, and the bank applied such proceeds to reduce the petitioner’s debt. The petitioner’s adjusted basis in the onion shed property at the time of its sale to CFE was $103,853.12; nevertheless, the petitioners did not report any loss from such transaction on their 1971 income tax return.

When the petitioner transferred his Meloland stock to Rummonds effective as of July 1, 1971, at the request of UCB, he was indebted to UCB in the total amount of $1,328,266. However, after he transferred his stock to Rummonds, he was no longer obligated to repay UCB on his debt. Nevertheless, his indebtedness continued to remain on the books of UCB, and as the collateral the bank held was liquidated, the monies received were applied to his indebtedness. The bank declared the remaining balance to be nonrecoverable sometime in 1977 after all the collateral had been liquidated. [pg. 377]

The petitioners’ individual income tax return for 1971 was prepared by Thomas A. Campbell, a certified public accountant. Mr. Campbell began preparing the petitioners’ returns in 1958 or 1960. In preparing the petitioners’ return for the year in issue, he relied solely on information furnished by the petitioner’s bookkeeper, including certain information on tax forms, and he never verified any information with the petitioner. Mr. Campbell was not told about the sale of the six lots to the newspaper; he was under the impression that UCB had taken over everything in foreclosure proceedings. Mr. Campbell also prepared the petitioners’ 1970 income tax return. On such return, he listed a gain of $19,506.60 resulting from the sale of the farm equipment to CFE. He also relied on the books and records furnished by the petitioner’s bookkeeper in the preparation of the petitioners’ 1970 tax return, and the sale of such farm equipment was revealed in such books and records. Mr. Campbell never maintained books and records for the petitioner, and the petitioner never asked Mr. Campbell any questions about his 1970 or 1971 income tax returns.

Meloland filed a small business corporation income tax return on a fiscal year basis beginning July 1 and ending June 30, ² and Mr. Campbell prepared such corporate tax return for its taxable year 1971 using information provided by Peat, Marwick, Mitchell & Co. He prepared such return on November 18, 1971, and the petitioner is listed as its 100-percent shareholder. Meloland reported taxable income of $38,319.58 for its fiscal year ending June 30, 1971. However, the petitioners did not report such amount on their 1971 individual income tax return.

During an Internal Revenue Service investigation of the petitioners’ 1971 income tax liability, the petitioner’s bookkeeper, in mid-1975, prepared a financial statement of his assets and liabilities as of 1971. The bookkeeper used information from the petitioner’s accounting records, and Mr. Campbell reviewed the statement and made adjustments thereto. The statement prepared by them set forth the assets and liabilities as of June 30, 1971, as follows: [pg. 378]

ASSETS                                    LIABILITIES
Cash in bank:                         Cash in bank:
Savings ……………  $1,174.06    UCB<1> ……………..   $1,769.36
Bank of America …….     638.00
Mexican bank ………. 175,000.00
Miscellaneous<1> ……     450.20
Accounts receivable:                  Accounts payable ……..  406,222.07
Produce exchange ……  29,519.76
Danenberg properties ..  57,411.70
CFE ……………….   2,509.92
Miscellaneous ………   1,500.00
Loans receivable:                     Loans payable:
Meloland<1> ……….. 198,680.00    UCB<1> …………….. 1,161,267.45
Deposits …………..     433.33    UCB-R.E<1> ………….   114.500.00
Cal. West …………..     8,557.37
Miscellaneous ……….    25,000.00
Investments:                          Contracts:
Meloland<1> ……….. 128,538.65    Crocker National bank ..    32,616.19
Farmers Tractor Co<1>..  47,500.00    Wilcox Manufacturing Co.     7,462.25
Shippers service ……   8,505.09
Labels …………….   1,500.00
Other:                                Other:
Personal residence ….  35,000.00    Allowance for
depreciation<1>……..   157,863.47
Land<1> ……………  32,851.10    Mortgage on residence ..    13,002.00
————
Buildings<1> ………. 228,865.69      Total ……………. 1,928,260.16
———-
Total ……………. 950,077.50
—————————————————————————
<1>Assets and liabilities taken over by UCB.

When Mr. Campbell reviewed such statement, he was unaware of many of the petitioners’ personal assets, such as jewelry and furs, and he valued the petitioners’ residence at cost rather than fair market value. Moreover, in a personal financial statement given by the petitioner to the Wells Fargo Bank on August 15, 1971, he listed assets including a life insurance policy, a note receivable in the amount of $45,000, and a one-half interest in a produce exchange building. None of these assets was included in the financial statement prepared by his bookkeeper for the IRS. The petitioner also maintained a bank account in Laredo, Tex., and the amount thereof was not reflected on the bookkeeper’s financial statement. The following chart is a summary of additional assets which the petitioners owned, or may have owned, on June 30, 1971: [pg. 379]

Additional assets
Note receivable ……………………………..$45,000.00
Life insurance policy (cash-surrender value)…….  8,559.00
Jewelry ……………………………………. 12,000.00
Two fur coats ………………………………. 15,000.00
Laredo bank account ………………………….  5,098.85
Adjustment to value of petitioners’ residence<1>… 12,900.00
One-half interest in produce exchange building<2>.. 31,675.00
———-
Total …………………………………….130,232.85
—————————————————————————
<1>The petitioner testified that a city assessor valued his residence at
$47,900 as of June 30, 1971. Therefore, such amount, minus the $35,000 figure
reported on the financial statement, results in a $12,900 increase.
<2>The petitioner testified that a city assessor valued such property at
$81,080 as of June 30, 1971, and that his interest was subject to an $8,865
mortgage.

If such total additional assets are added to the assets listed on the financial statement prepared by his bookkeeper, the petitioner’s liabilities exceed his assets by $847,949.81.

In his notice of deficiency, the Commissioner determined that the petitioners realized a long-term capital gain from the sale of the six lots measured by the difference between the net proceeds of the sale and the petitioner’s basis of $11,000 for the property; but the Commissioner now concedes that the petitioner’s basis in the property is $34,719.76. The Commissioner also determined that the petitioners realized a long-term capital gain of $757,465.04 from the transfer of their Meloland stock to Rummonds; in computing such gain, he concluded that the selling price of the stock was $1,123,003.04 and that their basis in such stock was $365,538. In the notice of deficiency, the Commissioner further determined that the petitioners realized a long-term capital gain from the sale of the onion shed property; for such purpose, he treated their basis as $71,002.02, but he now concedes that their basis in such property is $103,853.12 and asserts that they realized a long-term capital loss of $3,853.12 from such transaction. He also determined that the petitioners failed to report on their 1971 income tax return Mr. Danenberg’s share of the undistributed taxable income of Meloland for its fiscal year ending June 30, 1971, in the amount of $38,319.58. Finally, the Commissioner imposed the 50-percent addition to tax under section 6653(b) for fraud with intent to evade tax.

OPINION

The first issue for decision is whether the petitioners are [pg. 380] required to recognize gain or loss from the disposition of the six lots, the Meloland stock, and the onion shed property. The petitioner contends that such properties were transferred to UCB in connection with the bank’s foreclosure on such properties and that after such transfers, the bank forgave his debts. He claims that the transactions were not sales of the collateral by him but that such transactions were integral parts of the cancellation of all the petitioner’s indebtedness to the bank. He maintains that his position is buttressed by the fact that he never received the proceeds from the disposition of the properties, that the bank never assigned a specific value to the individual assets which it held as collateral, and that none of the bank’s loans to him were purchase-money mortgages. He further contends that any income he may have realized from the forgiveness of his debts is not to be recognized because he was insolvent at the time of such forgiveness.

On the other hand, the Commissioner contends that the transfers of the petitioner’s properties constitute “sales or exchanges” which are subject to the recognition provisions of section 1002. He maintains that the petitioner realized a gain (or loss) from the transfers to the extent the amount realized from the transfer exceeded (or was less than) his adjusted basis in the property. The Commissioner contends that the “amount realized” was the amount of the proceeds which the petitioner directed be paid to UCB to satisfy his indebtedness. Lastly, he maintains that the defense of insolvency is inapplicable to the recognition provisions of section 1002. We must agree with the Commissioner.

The issue we must consider is not whether an insolvent taxpayer realized income from the discharge or forgiveness of indebtedness See, e.g., United States v. Kirby Lumber Co., 284 U.S. 1 (1931); Lakeland Grocery Co. v. Commissioner, 36 B.T.A. 289 (1937). Rather, the issue to be decided is whether an insolvent taxpayer is required to recognize gain or loss under section 1002 from the sale or exchange of property. See Lutz & Schramm Co. v. Commissioner, 1 T.C. 682, 689 (1943).

Case law is clear that when a debt is discharged or reduced upon the debtor’s transfer of property to his creditor or a third party, such transaction is treated as a sale or exchange of the [pg. 381]debtor’s assets, and not as a mere transfer of assets in cancellation of indebtedness. ³ Bialock v. Commissioner, 35 T.C. 649, 660 (1961); R. O’Dell & Sons Co. v. Commissioner, 8 T.C. 1165, 1167 (1947), affd. 169 F.2d 247 (3d Cir. 1948); Lutz & Schramm Co. v. Commissioner, supra; Peninsula Properties Co., Ltd. v. Commissioner, 47 B.T.A. 84, 91 (1942); Carlisle Packing Co. v. Commissioner, 29 B.T.A. 514, 515 (1933). As this Court stated in R. O’Dell & Sons Co. v. Commissioner, supra at 1167:

If an owner sells property for more than its basis, the assumption that there has been a taxable gain follows almost inevitably. This is as true where the consideration received is property as where it is cash. Sometimes, the transaction involves an atypical sort of consideration such as release of the transferor’s indebtedness. That does not prevent the transfer from being a sale or exchange resulting in capital gain or loss. ***

The commentators have observed that there are various methods of satisfying indebtedness, and each method produces different tax consequences:

The form of income created by a discharge of indebtedness depends generally upon the consideration given by the debtor for the discharge and the facts and circumstances surrounding the transaction. For example, if the debtor effectuates a discharge by a payment in money or the equivalent of money, any gain on the transaction is considered to be cancellation of indebtedness income. *** However, it is possible to discharge a debt in a variety of ways: e.g., by the performance of services; by the transfer of property other than money; or by any other agreement deemed effective by the parties to extinguish the debt. Thus the particular facts or circumstances of the transaction will determine whether the realized income is compensation, gain on the disposition of property, rent, dividends, or simply cancellation of indebtedness income. [J. Eustice, “Cancellation of Indebtedness and the Federal Income Tax: A Problem of Creeping Confusion,” 14 Tax L. Rev. 225, 231 (1959).]

The commentators have also recognized that when the fair market value of property transferred is less than the amount of debt discharged, a separate tax issue of gain or loss on the disposition of property is raised:

If rather than paying cash to discharge an obligation the debtor transfers other assets with a value less than the face amount of the debt, the difference should constitute income to the debtor under the Kirby Lumber principle. If the debtor’s basis in the property differs from its fair market value at the [pg. 382]time of transfer, the transaction simultaneously raises a separate tax issue of gain or loss on the disposition of property, for the transaction could be considered equivalent to selling the property for its fair market value and then using the proceeds to discharge the debt. [B. Bittker and B. Thompson, “Income from the Discharge of Indebtedness: The Progeny of United States v. Kirby Lumber Co.,” 66 Cal. L. Rev. 1159, 1172 (1978).]

The facts of this case clearly indicate that the petitioner was involved in two separate transactions each time he disposed of the assets held by UCB as collateral: (1) There was an initial transaction whereby he disposed of such properties through a sales arrangement with a third party; and (2) there was a second transaction whereby the proceeds of the sale were paid to the bank and applied to reduce the amount of his indebtedness, and after all the collateral of the petitioner had been liquidated, the balance of his outstanding loan was forgiven by the bank.

The record overwhelmingly establishes that the transactions whereby the petitioner disposed of the assets held as collateral by the bank were indeed sales of such assets. Although UCB may have had the power of controlling the final selling price, the petitioner was active in arranging the disposition of such assets. He conducted the negotiations with Mr. Fitch for the sale of the six lots, and he dealt with the principals of CFE for the sale of the onion shed property. The bank postponed four trustee sales to allow the petitioner to conduct his negotiations with CFE concerning such sale. The petitioner was active in the general settlement of his debts with other creditors in 1970 and 1971; such conduct also indicates that the petitioner’s arrangements for the disposition of the collateral were not merely passive settlements with UCB. The evidence in the record in this case also indicates that both the bank and the petitioner perceived that the disposition of the six lots, the onion shed property, and the Meloland stock were sales of such collateral.

Moreover, the fact that such transactions may have taken place under the threat of foreclosure proceedings instituted by the bank is irrelevant to the determination of whether the petitioner is required to recognize a gain or loss. The Supreme Court in Helvering v. Hammel, 311 U.S. 504 (1941), and its companion case of Electro-Chemical Engraving Co. v. Commissioner, 311 U.S. 513 (1941), did away with the distinction between forced and voluntary sales. A voluntary sale and a mortgage foreclosure are both “dispositions” within the scope of the gain or loss provisions of section 1001. [pg. 383]

It is also irrelevant that no specific value was applied to each item of the petitioner’s collateral, that none of the bank’s loans were purchase-money mortgages, or that the petitioner never received the proceeds from the various transactions. As a result of each transaction, the petitioner received the benefit of having the proceeds applied to his debts, and except in the case of the transfer of the Meloland stock to Rummonds, the amount of the benefit was defined. It makes no difference that the petitioner directed the purchasers of the assets to forward the money directly to the bank. See, e.g., Peninsula Properties Co., Ltd. v. Commissioner, 47 B.T.A. at 91. Such action was merely for the convenience of the parties to the transactions. The sale of the six lots to the newspaper, the sale of the onion shed property to CFE, and the transfer of the Meloland stock to Rummonds were no different from the sale of the farm equipment to CFE in October 1970. The petitioner recognized that such transfer of the farm equipment constituted a sale, and he reported the gain realized from such sale on his 1970 income tax return. As this Court stated in Peninsula Properties Co., Ltd. v. Commissioner, supra at 91: “In each case the transaction is treated as if the transferor had sold the asset for cash equivalent

*** and had applied the cash to the payment of the debt.”

Lastly, the petitioner’s reliance on Liberty Mirror Works v. Commissioner, 3 T.C. 1018 (1944), is misplaced. In Liberty Mirror, the bank held a mortgage on the taxpayer’s property to secure a loan. As part of its settlement with the bank, the taxpayer agreed to forward the proceeds from the sale of such property to the bank, and since the taxpayer’s debt exceeded the proceeds from the sale, the bank agreed to cancel the taxpayer’s remaining indebtedness. This Court held that the cancellation of the taxpayer’s remaining indebtedness constituted a gift and that, therefore, the taxpayer realized no income. The Court did not consider the issue of whether the taxpayer was required to recognize a gain or loss on the sale of such property to the third party; it is that issue that we must decide in the petitioner’s case.

We now reach the primary issue in this case of whether the [pg. 384] insolvency of a taxpayer relieves him of the requirement of section 1002 ⁴ that he recognize a gain or loss on the disposition of property. Section 1001(a) provides:

The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 1001(b) defines “amount realized” as “the sum of any money received plus the fair market value of the property (other than money) received.” Section 1002 provided “Except as otherwise provided in this subtitle, on the sale or exchange of property the entire amount of the gain or loss, determined under section 1001, shall be recognized.”

The petitioner contends that any gain or loss that he may have realized on the disposition of his property is not recognized because the “Except” phrase of section 1002, read in conjunction with section 1.61-12(b)(1), Income Tax Regs., “exempts by implication” the recognition of gain or loss in the case of an insolvent taxpayer. We must disagree with the petitioner.

Section 1.61-12(b)(1) provides in part:

Income is not realized by a taxpayer by virtue of the discharge *** of his indebtedness *** by virtue of an agreement among his creditors not consummated under any provision of the Bankruptcy Act, if immediately thereafter the taxpayer’s liabilities exceed the value of his assets. ***

Section 1.61-12(b)(1) sets forth the law regarding the realization of income through the forgiveness of indebtedness of an insolvent taxpayer; such section has no bearing on the recognition of gain or loss on the sale or disposition of property by an insolvent taxpayer. Moreover, the petitioner’s contention that the insolvency of the debtor precludes recognition of gain or loss under section 1002 is inconsistent with the language and intent of the regulations under such section. Section 1.1002-1(b) and (c), Income Tax Regs., provides in part:

• (b) Strict construction of exceptions from general rule.The exceptions from the general rule requiring the recognition of all gains and losses, like other exceptions from a rule of taxation of general and uniform application, are strictly construed and do not extend either beyond the words or the underlying assumptions and purposes of the exception. Nonrecognition is accorded by the [pg. 385]Code only if the exchange is one which satisfies both (1) the specific description in the Code of an excepted exchange, and (2) the underlying purpose for which such exchange is excepted from the general rule. *** As elsewhere, the taxpayer claiming the benefit of the exception must show himself within the exception.
• (c) Certain exceptions to general rule. Exceptions to the general rule are made, for example, by sections 351(a), 354, 361(a), 371(a)(1), 371(b)(1), 721, 1031, 1035 and 1036. These sections describe certain specific exchanges of property in which at the time of the exchange particular differences exist between the property parted with and the property acquired, but such differences are more formal than substantial. As to these, the Code provides that such differences shall not be deemed controlling, and that gain or loss shall not be recognized at the time of the exchange. The underlying assumption of these exceptions is that the new property is substantially a continuation of the old investment still unliquidated; and, in the case of reorganizations, that the new enterprise, the new corporate structure, and the new property are substantially continuations of the old still unliquidated.

[Emphasis supplied.]

The proposition that the exceptions to the general rule of taxation must be strictly construed has generally been accepted and applied by the courts. Bank of Commerce v, Tennessee, 161 U.S. 134, 146, (1896); Cappel House Furnishing Co. v. United States, 244 F.2d 525, 529 (6th Cir. 1957). Moreover, section 1.1002-1(c) does not include the insolvency of a debtor as an exception within its purview. The situations which are exempted from the recognition provision are those in which the recognition of gain or loss is merely postponed until a later taxable disposition of the property. In the present case, the petitioners are not seeking merely a postponement of the recognition of gain; they are seeking a complete exemption of such gain. There is no “later disposition” of the property by the taxpayer. The final disposition of the properties by the petitioner occurred when he transferred such properties to the various third parties, and it is such final disposition on which the petitioner is taxable. See Woodsam Associates v. Commissioner, 198 F.2d 357, 359 Cir. 1952), affg. 16 T.C. 649 (1951) (realization of gain postponed for taxation until there was a final disposition of the property at the time of the foreclosure sale).

Finally, although this precise situation appears not to have been adjudicated in the past, the commentators have recognized that although insolvency would preclude the realization of income resulting from the cancellation of indebtedness, insolvency [pg. 386]would not eliminate gain when the transaction involved is a separate sale of property:

The question whether a transfer of property for the cancellation of indebtedness is simply a sale rather than forgiveness of an indebtedness is important where the debtor is insolvent. Insolvency would not eliminate the gain arising from a separate voluntary sale of property, whereas a mere cancellation of indebtedness might not result in income to an insolvent. [2 J. Mertens, Law of Federal Income Taxation, sec. 11.21, p. 119 n. 63 (1974 rev.).]

See also W. Warren & N. Sugarman, “Cancellation of Indebtedness and Its Tax Consequences: I,” 40 Colum. L. Rev. 1326, 1353-1354 (1940); J. Eustice, “Cancellation of Indebtedness and the Federal Income Tax: A Problem of Creeping Confusion,” 14 Tax L. Rev. 225, 234-235 (1959).

For such reasons, we hold that the petitioner realized a gain on the sale of the six lots to the newspaper, measured by the difference between the net proceeds paid to UCB on behalf of the petitioner and his basis in such property, and that he is required to recognize such gain under section 1002, subject to the provisions of section 1201 et seq., relating to capital gains and losses. We also hold that the petitioner realized a loss on the sale of the onion shed property to CFE, measured by the difference between the selling price and his adjusted basis in such property, and that such loss is recognizable under section 1002, subject to the provisions of section 1201 et seq., relating to capital gains and losses.

The transfer of the Meloland stock presents additional questions since actual cash proceeds were not transferred to UCB by a third party. Therefore, we must determine what amount the petitioner received as a result of the transfer of his Meloland stock. The Commissioner contends that, in exchange for his transfer of the Meloland stock, the petitioner received a discharge of the entire amount of his indebtedness to UCB at that time, that is, $1,123,003.04. ⁵ We find his position to be unsupported by the record.

The record is clear that UCB did not consider the petitioner’s debt as having been satisfied by the transfer of his Meloland stock to Rummonds even though it released him from personal liability for such debt at that time. Indeed, the bank looked to [pg. 387]Meloland and its successor corporation for further payments on the petitioner’s debt under its continuing guarantee for his loans and actually collected such payments as late as April 1975. Moreover, in September 1970, when the bank began to consider the amount the petitioner’s assets would bring in liquidation, it estimated that there would be a final loss of approximately $800,000 on the petitioner’s account. In addition, Edward E. Gregg, a vice president of UCB, who was involved with the petitioner’s account, testified that such stock was not worth over $1 million; and Mr. Mann, who was the sole shareholder of Rummonds at the time of the transfer of the Meloland stock, testified that Rummonds did not pay over $1 million for such stock. Therefore, it is clear that UCB did not regard the Meloland stock as satisfying the petitioner’s total debt to the bank. We must then consider other methods of valuation to determine what amount the bank received upon the surrender of the petitioner’s interest in Meloland.

For some purposes, the fair market value of stock is determined by examining the net worth and earnings potential of a corporation, but in this case, the parties to the transfer were not relying on a value so determined. The record in this case establishes that UCB considered the value of the physical assets of Meloland as the value it would receive upon the liquidation of the petitioner’s stock. The bank hoped to find a buyer for the Meloland feedlot, and its appraisals of the Meloland stock were based on what it expected to realize on a sale of the physical assets of Meloland. Moreover, in March 1971, the petitioner estimated that the value of the Meloland stock was indicated by the amount for which the Meloland feedlot could be sold. Finally, the net worth of Meloland is not helpful in this case since the purpose of our inquiry is to determine the value of the property, in effect, transferred to UCB to be applied to the petitioner’s indebtedness to it. Therefore, we consider only the value of the physical assets of Meloland on June 30, 1971, as the amount that UCB received when the petitioner surrendered his stock to its nominee.

Meloland’s balance sheet revealed that its physical assets were worth $579,323 on June 30, 1971, and we find that such amount represents the value of such assets since we have no evidence to indicate otherwise. We hold that such amount was the amount transferred to UCB by the petitioner upon the surrender of his [pg. 388]stock to its nominee and that such amount constitutes the amount realized by the petitioner as a result of such transfer. For these reasons, we hold that as the result of the transfer of the Meloland stock, the petitioner is required to recognize under section 1002 a gain measured by the amount realized over his basis in such stock, ⁶ subject to the provisions of sections 1201 et seq., relating to capital gains and losses.

Next, we must consider whether the petitioner must recognize income from the discharge of indebtedness equal to the difference between his total indebtedness to UCB and the total amount of the collateral applied in partial satisfaction of such debt. It is a well-established principle that a debtor realizes no income from the discharge of indebtedness if he is insolvent both before and after such discharge. Sec. 1.61-12(b)(1), Income Tax Regs.; Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 F.2d 95 (5th Cir. 1934), revg. 27 B.T.A. 651 (1933); Astoria Marine Construction Co. v. Commissioner, 12 T.C. 798 (1949); Main Properties, Inc. v. Commissioner, 4 T.C. 364 (1944); Kramon Development Co. v. Commissioner, 3 T.C. 342 (1944). However, the Commissioner contends that the petitioner has failed to present adequate evidence of insolvency. He maintains that the financial statement which the petitioner’s bookkeeper prepared indicating his net worth on June 30, 1971, is incomplete and untrustworthy because many of the petitioner’s personal assets were omitted, some assets were valued at cost instead of fair market value, and the petitioner did not certify the statement’s authenticity and completeness. The Commissioner also claims that the petitioner gave a contradictory financial statement to the Wells Fargo Bank in August 1971 which indicated that he was solvent at that time.

The financial statement prepared by the petitioner’s bookkeeper [pg. 389] does have its shortcomings. However, Mr. Campbell, the certified public accountant who prepared the petitioners’ income tax returns, made corrections that he felt were necessary to make the statement more accurately reflect the petitioner’s net worth. Moreover, even if the assets which were omitted from the bookkeeper’s statements are added to the assets listed on such statements, and even if the properties are valued at their fair market value, the liabilities of the petitioner far exceed his assets. As to the contradictory statement given by the petitioner to the Wells Fargo Bank, he testified that the figures listed on such statement are in error. He also implied that the bank officer at Wells Fargo was merely concerned with completing the statement without too much regard for accuracy so that the bank could process a loan to CFE. In the light of all these circumstances, we are satisfied and hold that the petitioner has sufficiently proved his insolvency on June 30, 1971. Accordingly, the petitioner did not realize any income resulting from the partial discharge of his indebtedness by UCB. See Bialock v. Commissioner, 35 T.C. 649 (1961).

The second issue for consideration is whether the petitioner was a shareholder of Meloland on June 30, 1971, and, therefore, should have included such corporation’s undistributed taxable income in his gross income for 1971 under section 1373. Section 1373 provides in part:

• (a) General Rule.-The undistributed taxable income of an electing small business corporation for any taxable year shall be included in the gross income of the shareholders of such corporation in the manner and to the extent set forth in this section.
• (b) Amount Included in Gross Income.-Each person who is a shareholder of an electing small business corporation on the last day of a taxable year of such corporation shall include in his gross income, for his taxable year in which or with which the taxable year of the corporation ends, the amount he would have received as a dividend, if on such last day there had been distributed pro rata to its shareholders by such corporation an amount equal to the corporation’s undistributed taxable income for the corporation’s taxable year. For purposes of this chapter, the amount so included shall be treated as an amount distributed as a dividend on the last day of the taxable year of the corporation. [Emphasis supplied.]

The petitioner contends that he was no longer a shareholder of Meloland on June 30, 1971, the last day of its taxable year, because he had disposed of his stock on May 26, 1971, when he [pg. 390]signed the agreement to transfer such stock to Rummonds and executed an assignment separate from certificate to it.

The question of whether a taxpayer has made a valid transfer of property which is effective for Federal income tax purposes is an issue of fact. Wilson v. Commissioner, 560 F.2d 687, 690-691 (5th Cir. 1977), affg. a Memorandum Opinion of this Court. It is well established that for purposes of determining who is a shareholder under the provisions of subchapter S, beneficial ownership of the stock rather than technical legal title is controlling (Hoffman v. Commissioner, 47 T.C. 218 (1966), affd. per curiam 391 F.2d 930 (5th Cir. 1968); Kean v. Commissioner, 51 T.C. 337 (1968), affd. on this issue 469 F.2d 1183 (9th Cir, 1972)), and the incidents of taxation are determined by the real ownership of the stock, and not where mere naked title lies (see Rupe Investment Corp. v. Commissioner, 30 T.C. 240 (1958), affd. 266 F.2d 624 (5th Cir. 1959); Stiefel v. Commissioner, 9 T.C. 576 (1947)). The evidence on this issue overwhelmingly indicates that the petitioner was the sole shareholder of Meloland on June 30, 1971, since the assignment separate from certificate, executed on May 26, 1971, was not to take effect until after June 30 of that year.

Section 1.1373-1(a)(2), Income Tax Regs., provides in part:

A donee or purchaser of stock in the corporation is not considered a shareholder unless such stock is acquired in a bona fide transaction and the donee or purchaser is the real owner of such stock. The circumstances, not only as of the time of the purported transfer but also during the periods preceding and following it, will be taken into consideration in determining the bona fides of the transfer. ***

Under such section, we must give careful consideration to all the circumstances surrounding the purported stock transfer to Rummonds on May 26, 1971. California law also provides that to determine the effective date of a transfer of corporate stock, all the surrounding facts and circumstances must be examined. Cal. Comm. Code, sec. 8309 (West 1964); Orpheum Bldg. Co. v. Anglim, 127 F.2d 478, 481 (9th Cir. 1942); Robbins v. Pacific Eastern Corp., 8 Cal. 2d 241, 65 P.2d 42, 59 (1937).

As a first matter, the assignment separate from certificate which the petitioner executed to Rummonds on May 26 states plainly: “This Assignment to be effective July 1, 1971. Dated 5-26-71.” Furthermore, stock certificate number two, which [pg. 391]transferred the stock of Meloland from the petitioner to Rummonds, was dated July 1, 1971. This Court has held that:

Where a taxpayer has entered into a written agreement *** that provides for the specific terms of a transaction the tax consequences of which are in issue, we have applied the rule that “strong proof” must be adduced by the taxpayer if he seeks to establish a position at variance with the language of the agreement to which he was a party. *** [Lucas v. Commissioner, 58 T.C. 1022, 1032 (1972).]

We find that the petitioner has failed to present sufficient evidence, much less the “strong proof” required under the holding of the Lucas case, to establish that the effective date of the stock transfer to Rummonds was not July 1, 1971, the effective date of the transfer set forth on all the relevant documents.

The petitioner argues that the assignment separate from certificate which he executed on May 26, 1971, had the effect of transferring title to the Meloland stock to UCB at such time since UCB already held the certificate to such stock. However, Mr. Mann, who was the sole shareholder of Rummonds, who was the attorney for UCB handling the transfer of the stock, and who considers himself an expert in the area, testified that the May 26 agreement by which the petitioner “sold, assigned and transferred” his stock in Meloland to Rummonds was nothing more than a binding commitment by the petitioner to transfer such stock and that such was his intention when he drew up the agreement. Moreover, the testimony of the principals of such transaction indicates that the bank and Rummonds considered the effective date for the transfer to be July 1, 1971. Mr. Mann stated unequivocally that the effective date for such transfer was July 1, 1971. Mr. Gregg, the vice president at UCB who worked with the petitioner’s account, also testified that the effective date was July 1, 1971. Furthermore, the accountants’ report for Meloland examining the balance sheet of such corporation as of June 30, 1971, states that its subchapter S status “automatically terminated on July 1, 1971 when the stock of the Company was transferred to a corporate stockholder.” (Emphasis added.) Finally, the petitioner’s failure to transfer the corporate books and records until July or August of that year suggests that he did not consider the transfer to have taken effect in May of that year.

We are not persuaded by the petitioner’s contention that the [pg. 392] bank’s reconveyance of the deed to his residence on June 29, 1971, is evidence that the stock transfer took place on May 26. The record in this case is replete with evidence that the petitioner cooperated with the bank’s liquidation of his collateral at every possible opportunity and that the bank was responsive to and appreciative of such cooperation. The onion shed property was not sold until September 1971, but the petitioner’s residence was reconveyed to him substantially prior to such sale. In the light of the obvious cooperation between the petitioner and UCB, it is not at all surprising that UCB reconveyed the title to his residence to him shortly before the effective date of the transfer of the stock when it was assured that the liquidation of his collateral was nearly completed.

The petitioner’s reliance on Pacific Coast Music Jobbers, Inc. v. Commissioner, 55 T.C 866 (1971), affd. 457 F.2d 1165 (5th Cir. 1972), is misplaced. In Pacific Coast, this Court held that a sale of stock had taken place in the year in which the sale agreements had been executed despite the fact that such shares were placed with an escrow agent. The Court rejected the taxpayer’s contention that a sale had not taken place until 5 years later when the stock was released from escrow, and it held that the sellers used such escrow account merely as a security device to guarantee future payment and that a completed sale of the stock had taken place in the year in which the agreement was made. The Court considered numerous circumstances to conclude that the taxpayer had acquired all the “accouterments of ownership” (55 T.C. at 877) on the sales date, and that the taxpayer obtained “domination and control” (55 T.C. at 877) over the corporation despite the fact that the shares were held in escrow. The Court in Pacific Coast was not confronted with the situation presented in this case where there is an unambiguous document containing the effective date of the stock transfer. Accordingly, we hold that the petitioner was the sole shareholder of Meloland on June 30, 1971, the last day of the taxable year of such corporation. Therefore, he must include in gross income the undistributed taxable income of Meloland under section 1373.

The last issue for consideration is whether any part of the underpayment of taxes for the year in issue was due to fraud with intent to evade tax within the meaning of section 6653(b), which provides in part: [pg. 393]

(b) Fraud.-If any part of any underpayment *** of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. ***

The Commissioner has the burden of proving, by clear and convincing evidence, that some part of the underpayment for the year was due to fraud. Sec. 7454(a); Rule 142(b), Tax Court Rules of Practice and Procedure; Levinson v. United States, 496 F.2d 651 (3d Cir. 1974), cert. denied 419 U.S. 1040 (1974); Estate of Pittard v. Commissioner, 69 T.C. 391 (1977); Estate of Temple v. Commissioner, 67 T.C. 143 (1976); Imburgia v. Commissioner, 22 T.C. 1002 (1954); Petit v. Commissioner, 10 T.C. 1253 (1948). To establish fraud, the Commissioner must show that the taxpayer intended to evade taxes, which he knew or believed he owed, by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States, 398 F.2d 1002, 1004 (3rd Cir. 1968), cert. denied 393 U.S. 1020 (1969); Webb v. Commissioner, 394 F.2d 366, 377, (5th Cir. 1968), affg. a Memorandum Opinion of this Court; Acker v. Commissioner, 26 T.C. 107, 112-113 (1956).

The Commissioner’s sole contention with respect to fraud is that the petitioner failed to report the gain on the sale of the six lots with the deliberate intent to evade taxes. He claims that the petitioner is an intelligent and experienced businessman familiar with real estate procedures and that he has demonstrated his business acumen through the numerous business ventures in which he is involved. The Commissioner maintains that the petitioner was aware of the correct reporting activity with respect to the disposition of property as is evidenced by his reporting the sale of the farm equipment to CFE in October 1970 on his 1970 income tax return. The Commissioner concludes that the petitioner’s failure to report a similar occurrence 1 year later is a deliberate intent to evade tax. We must disagree with the Commissioner.

The primary distinction between the sale of the six lots and the sale of the farm equipment is that the bank had filed a notice of foreclosure with respect to the lots approximately 3 months before their sale to the newspaper. It is not unreasonable to conclude that the petitioner thought that he no longer owned the property once such notice was filed. Indeed, even the petitioner’s accountant, Mr. Campbell, testified that he thought the bank took over everything in foreclosure proceedings. In any event, [pg. 394] given the complexity of the facts and issues in this case, we can accept the contention that a person, not an expert in tax law, may not have understood the tax consequences of the transfer of the six lots. Arnold v. Commissioner, 14 B.T.A. 954, 971-972 (1928) (fraud penalty not imposed where facts were complicated and correct tax liability was difficult to ascertain). Accordingly, we find that the Commissioner has failed in his burden of establishing fraud from the petitioner’s failure to report the gain on the sale of the six lots.

In conclusion, we hold: (1) That the petitioners realized a long-term capital gain on the sale of the six lots to the newspaper and that such gain is recognizable pursuant to section 1002, subject to the provisions of section 1201 et seq., relating to capital gains and losses; (2) that they realized a long-term capital loss on the sale of the onion shed property to CFE and that such loss is recognizable pursuant to section 1002, subject to the provisions of section 1201 et seq., relating to capital gains and losses; (3) that they realized a long-term capital gain on the disposition of the Meloland stock and that such gain is recognizable pursuant to section 1002, subject to the provisions of section 1201 et seq., relating to capital gains and losses; (4) that they did not realize any income resulting from the partial discharge of their indebtedness by UCB since they were insolvent at such time; (5) that Mr. Danenberg was the sole shareholder of Meloland on June 30, 1971, and must include such corporation’s undistributed taxable income in his gross income for the year in issue pursuant to section 1373; and (6) that no part of the underpayment of tax for the year in issue was due to fraud.

Decision will be entered under Rule 155.

 ¹ All statutory references are to the Internal Revenue Code of 1954, as in effect during the year in issue, unless otherwise indicated.

 ² We will refer to Meloland’s taxable year by the calendar year in which it ends.

 ³ Only one case treated such a transaction as a surrender in cancellation of indebtedness. Turney’s Estate v. Commissioner, 126 F.2d 712 (5th Cir. 1942), revg. a Memorandum Opinion of this Court. However, the result in such case is inconsistent with all other cases and has not been followed in later cases.

 ⁴ Sec. 1002 was repealed by the Tax Reform Act of 1976, Pub. L. 94-455, sec. 1901, 90 Stat. 1799, and similar language now appears in sec. 1001(c), effective for taxable years beginning after Dec. 31, 1976.

 ⁵ According to the bank records, however, the petitioner was indebted to UCB in the amount of $1,328,266 when he transferred his stock to Rummonds on July 1, 1971.

 ⁶ In his notice of deficiency, the Commissioner determined that the petitioner’s basis in the Meloland stock was $365,538 computed as follows:

Capital stock ………………………….  $ 10,000
Additional paid-in capital ………………   150,000
Undistributed 1120S taxable income ……….     6,858
Loans to corporation ……………………   198,680
——–
Total cost basis ……………………..   365,538

However, in the second issue in this case, we hold that the petitioner must include in income the undistributed taxable income of Meloland for 1971 in the amount of $38,319.58. Therefore, his basis in such stock should be adjusted under sec. 1376 to take into consideration the inclusion of such amount in his income.

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