From:  Richard Ogg
Date:  Sat, 08 Sep 2007

Hi Michael,

I'm working through a "short sale" for one of my clients.

I found a case, Briarpark v. Commissioner (T.C. Memo 1997-298, 6/30/1997), where the Tax Court held a short sale was equivalent to a foreclosure because the borrower was relieved from debt and relinquished the property in the same transaction. As a result, the non-recourse debt was included in the sale proceeds, resulting in a capital gain.

The Fifth Circuit Court of Appeals upheld the Tax Court's decision (99-1 USTC ¶ 50,209, 1/6/1999), making this case more recent that Rev. Rul. 92-99, cited in your article.

Did you consider Briarpark when writing your article? Am I missing something?

Thank you for your help!

Blessings,
Richard Ogg, EA
The Masters Tax Service

Answer

Date:  26 Sep 2007

Hello Richard,

Thank you for writing.

It looks like I'm the person who missed something. The Briarpark decision was buried in cases under Internal Revenue Code Section 1001 (Computation of Gain or Loss), while I was mostly studying Section 108 (Cancellation of Debt Income).

There isn't much discussion of this situation in the literature, presumably because in the past "short sales" weren't common.

First, taxpayers will be interested to know the IRS took the position that the nonrecourse debt that Briarpark was relieved from incidental to its sale should be included in sale proceeds. Briarpark evidently wanted to exclude the debt cancellation under the insolvency exclusion.

The IRS and Fifth Circuit found that since the buyer and seller both made a condition that the debt be cancelled, the debt cancellation was in fact an integral part of the sale. The bank/lender documented making a business decision that its best alternative was to permit the cash sale. Under Treasury Regulations Section 1.1001-2, the amount realized from a sale of property includes the amount of liabilities from which the transferor is discharged as a result of the sale or disposition, regardless of the fair market value of the security. The portion of the liability resulting in a taxable discharge of indebtedness (recourse debt in excess of the fair market value of the property) is excluded from the sale proceeds.

Thank you, again Richard, for bringing this to my attention. You have performed a valuable service for the readers of this newsletter. (And I get to eat humble pie!)

Good luck!
Mike Gray

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