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Commissioner of Internal Revenue v. Freihofer

March 15, 1939

COMMISSIONER OF INTERNAL REVENUE
v.
FREIHOFER, AND THREE OTHER CASES.



Appeal from United States Board of Tax Appeals.

Author: Maris

Before MARIS and CLARK, Circuit Judges, and KALODNER, District Judge.

MARIS, Circuit Judge.

These petitions by the Commissioner of Internal Revenue to review four decisions of the Board of Tax Appeals present for our determination a single question. It is this. Is a total loss which is suffered by a land owner as a result of the foreclosure of a mortgage upon his land which had been given by a prior owner, a loss resulting from the sale of a capital asset within the meaning of Section 117 of the Revenue Act of 1934? (26 U.S.C.A. § 101).

In each of the case before us the mortgaged property, which was admittedly a capital asset as defined by the act, was sold by the sheriff under an execution writ issued in a Pennsylvania statutory foreclosure proceeding for a price which was less than the amount of the mortgage and left nothing for the taxpayer. Each taxpayer claimed the right to deduct the entire amount of the loss under Section 23 of the Revenue Act of 1934, 26 U.S.C.A. § 23. In each case the Commissioner held that the loss resulted from the sale of a capital asset and was accordingly deductible to the extent of $2,000 only, under the express terms of Section 117(d) of the Revenue Act, 26 U.S.C.A. § 101(d). Upon separate petitions filed by the taxpayers the Board of Tax Appeals held that the losses were deductible in their entirety, reversing the Commissioner's action. Greisler et al. v. Commissioner, 37 B.T.A. 542.

Section 23 of the Revenue Act of 1934 provides that "In computing net income there shall be allowed as deductions: * * * In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise - * * * if incurred in any transaction entered into for profit, though not connected with the trade or business; * * * ." 26 U.S.C.A. § 23(e). This language must be read in connection with Section 117, however, which provides that in the case of a taxpayer other than a corporation only certain percentages of "the gain or loss recognized upon the sale or exchange of a capital asset shall be taken in to account in computing net income" the percentage being determined by the period for which the property has been held. Subdivision (d) of that section further provides that "Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges."

It will be seen that the decision of the question before us turns upon the meaning to be given to the word "sale" as used in Section 117 of the Revenue Act. If it refers only to voluntary sales by the taxpayers the question must be decided in their favor. If on the other hand it includes a judicial sale conducted in an adversary proceeding for the foreclosure of a mortgage prior in lien to the taxpayer's title the contention of the Commissioner must be sustained.

At first blush it would appear that the word is used in a broad sense since it is without qualification. The question is, however, not so simply resolved.The phrase used in the statute is "the gain or loss recognized upon the sale or exchange of a capital asset." While no modifying words are used it is obvious that the gain or loss referred to is that of the taxpayer and that the capital asset mentioned is likewise his. Viewing the phrase in this light there arises at least a doubt whether the Congress intended to give the word "sale" the broader meaning claimed for it. That doubt makes it appropriate for us to examine the legislative history of the act. (Gay v. Ruff, 292 U.S. 25, 54 S. Ct. 608, 78 L. Ed. 1099, 92 A.L.R. 970), expecially the reports of the Congressional committees. Binns v. United States, 194 U.S. 486, 24 S. Ct. 816, 48 L. Ed. 1087; Duplex Co. v. Deering, 254 U.S. 443, 41 S. Ct. 172, 65 L. Ed. 349, 16 A.L.R. 196.

Special treatment for gains and losses resulting from the sale or exchange of capital assets first appeared in the Revenue Act of 1921, 42 Stat. 227. the report of the Committee on Ways and Means of the House of Representatives*fn1 clearly discloses that the Congress in introducing these new provisions had in mind voluntary sales by taxpayers and desired to reduce the tax upon capital gains in order to encourage such transactions. The report of the Finance Committee*fn2 of the Senate discloses the same thought. These provisions were continued in substantially the same form in the Revenue Acts of 1924, 1926, 1928 and 1932. When the Revenue Act of 1934 came under consideration, however, the Congress introduced the new method of taxing gains from the sale or exchange of capital assets which is set forth in Section 117 of the Act and at the same time, as we have seen, limited the deduction of losses from sales or exchanges of capital assets to $2,000 in excess of the gains from such transactions.The reason for this change appears from the following excerpts from the report upon the bill of the Committee on Ways and Means of the House of Representatives:*fn3

"Existing law provides in section 101 for a special treatment of the gains and losses resulting from the sale of capital assets held over 2 years. * * *

"Our present system has the following defects:

"First. It produces an unstable revenue - large receipts in prosperous years, low receipts in depression years.

"Third. Taxpayers take their losses within the 2-year period and get full benefit therefrom, and delay taking gains until the 2-year period has ...


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