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DELBERT M. BUNCH AND ERNESTINE L. BUNCH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBunch v. Comm'rDocket No. 18774-11.
United States Tax Court T.C. Memo 2014-177; 2014 Tax Ct. Memo LEXIS 173; 108 T.C.M. 226;August 28, 2014, FiledDecisions will be entered under
Rule 155 .Ps claimed a deduction for a bad debt loss on their 2006 Schedule A, Itemized Deductions. Ps subsequently filed a Form 1040X, Amended U.S. Individual Income Tax Return, and characterized the claimed bad debt loss as a theft loss on their Schedule C, Profit or Loss From Business. R determined that Ps were not eligible for a theft loss or bad debt loss deduction for the 2006 tax year and issued a notice of deficiency disallowing a current deduction for the claimed loss.
Held : Ps are unable to deduct their loss as a theft loss for the 2006 tax year.Held, further , Ps are unable to deduct their loss as a bad debt loss for the 2006 tax year.2014 Tax Ct. Memo LEXIS 173">*173Delbert M. Bunch and Ernestine L. Bunch, Pro se.Wesley J. Wong , for respondent.WHERRY, Judge.WHERRY*178 MEMORANDUM FINDINGS OF FACT AND OPINION WHERRY,
Judge : This case is before the Court on a petition for redetermination of a deficiency in income tax respondent determined for petitioners' 2006 tax year. On or before October 12, 2007, petitioners filed a joint Federal income tax return for the 2006 tax year. On January 26, 2009, petitioners filed a Form 1040X, Amended U.S. Individual Income Tax Return, for the 2006 tax year. On June 29, 2011, respondent issued to petitioners a notice of deficiency for the 2006 tax year disallowing a deduction for petitioners' claimed bad debt loss of $4,044,096.2014 Tax Ct. Memo LEXIS 173">*174 for the 2006 tax year, and if not, (2) whether petitioners may claim a theft loss of $4,011,696*179 FINDINGS OF FACTAccording to their 2006 Federal income tax return, petitioner Delbert M. Bunch is a broker, and petitioner Ernestine L. Bunch a consultant. At the time the petition was filed, Mr. and Mrs. Bunch resided in Las Vegas, Nevada.
Loan to Mortgage Co .In 2000 petitioners discovered an opportunity in a newspaper advertisement to invest in U.S.A. Commercial Mortgage Co. (Mortgage Co.). Mortgage Co. raised money from investors and made loans to developers for the construction of real estate. In May 2000 Mortgage Co. created the Diversified Trust Deed Fund (Diversified Fund), an unregistered investment fund. Joseph D. Milanowski, then Mortgage Co.'s president, was actively involved in the Diversified Fund.
On June 26, 2000, petitioners and some of their family members loaned Mortgage Co. $10 million, of which petitioners contributed $4,044,096, in exchange for a promissory note (note). According to the note, petitioners and their colenders were to2014 Tax Ct. Memo LEXIS 173">*175 be paid interest at a rate of 20% per annum, with the principal due one year after the final interest payment. The note provided that the loan was secured by "one or more collateral assignments of deeds of trust." The note contained an acceleration clause which stated that "[u]pon the occurrence of an Event of Default, Lender may declare the entire principal balance of the note then *180 outstanding * * * to be due and payable immediately." Mr. Milanowski signed the Note on Mortgage Co.'s behalf in his capacity as its president.
In 2001 several loans in Mortgage Co.'s portfolio apparently went into default. Petitioners were not aware of these defaults. They never received any monthly or quarterly statements with respect to their loans. They never knew what Mortgage Co. did with the principal from their note. Petitioners and their family members received their regular interest payments according to the note until March 31, 2006.
Mortgage Co.'s Bankruptcy Proceeding On April 13, 2006, Mortgage Co. filed for bankruptcy under chapter 11 of the United States Bankruptcy Code. According to its bankruptcy petition, Mortgage Co. had $50-$100 million in assets and $10-$50 million in outstanding liabilities2014 Tax Ct. Memo LEXIS 173">*176 at the time of filing. When Mr. Milanowski pleaded guilty to wire fraud on August 4, 2009, in connection with the Diversified Fund, his plea agreement with the United States stated more specifically that, as of April 13, 2006, when it filed for bankruptcy, Mortgage Co. had approximately $962 million in assets under its management.
On November 17, 2006, Mr. Bunch and a group of unsecured nonpriority claimants related to him filed a proof of claim for $11,358,662 against Mortgage *181 Co. in the U.S. Bankruptcy Court for the District of Nevada (bankruptcy court). Petitioners allege they filed the proof of claim in order to "prove * * * [their] loss and get tax refunds."
Nearly three years later, on July 9, 2009, the bankruptcy court allowed petitioners' claim against Mortgage Co. as a general unsecured claim in the amount of $11,358,662. The claim's allowance occurred before a $20 million interim distribution to creditors approved by the bankruptcy court on October 27, 2009. Petitioners received at least one distribution from Mortgage Co.'s bankruptcy estate though the record does not clearly establish its timing.
In a 2006 disclosure statement submitted to the court, Mortgage Co. estimated2014 Tax Ct. Memo LEXIS 173">*177 that it would have sufficient funds to pay 8%-33% of all general unsecured claims after payments to higher priority creditors. And at a 2007 meeting petitioners were advised that they could expect to recover around $500,000 of their loaned funds. In November 2012 the chapter 11 bankruptcy trustee reported that the first interim distribution, in late 2009, had covered 4.92% of allowed unsecured claims, on a pro rata basis, and that a second interim distribution in January 2012 had raised the aggregate percentage to 8.8%.
See Second Motion to Extend the USACM Liquidating Trust's Scheduled Termination *182 Date at 3,In re USA Commercial Mortgage Co ., No. BK-S-06-10725-LBR (Bankr. D. Nev. Nov. 14, 2012)*183 Donald R. Walker, a member of the Unsecured Creditors' Committee (committee) for Mortgage Co.'s bankruptcy proceeding, testified that the committee learned of "the loss" in the latter part of 2006, just before the bankruptcy plan was confirmed. During 2006 the committee discussed bringing criminal charges against Mr. Milanowski, and attorneys for some creditors communicated with the Federal Bureau of Investigation (FBI) about prosecuting him.
Mr. Bunch testified that petitioners learned of Mortgage Co.'s bankruptcy and that their loaned funds had been lost or stolen in 2006, through a meeting with Mr. Milanowski and examination of Mortgage Co.'s tax returns and financial statements. He also testified, however, that Mr. Milanowski did not reveal during the meeting that Mortgage Co. had fraudulently misrepresented its assets and liabilities in its bankruptcy filings,2014 Tax Ct. Memo LEXIS 173">*180 and that petitioners learned only "later" that Mortgage Co.'s reported financials were "untrue".
Tax Returns Petitioners filed a Form 1040, U.S. Individual Income Tax Return, for taxable year 2006. They claimed a bad debt deduction of $4,044,096. On their 2009 Form 1040X, they changed their claimed bad debt deduction of $4,044,096 to a theft loss deduction of $4,011,696.
*184 On June 29, 2011, respondent issued petitioners a notice of deficiency for taxable year 2006 determining a deficiency in income tax of $74,236.
OPINION Petitioners sought to deduct the unrecovered funds they had advanced to Mortgage Co. first as a bad debt loss and later as a theft loss. We examine both alternatives. Either way, deductions are a matter of legislative grace, and petitioners bear the burden of proving that they are entitled to the deduction claimed.
Rule 142(a) ;see also INDOPCO, Inc. v. Commissioner , 503 U.S. 79">503 U.S. 79Deputy v. Du Pont , 308 U.S. 488">308 U.S. 488New Colonial Ice Co. v. Helvering , 292 U.S. 435">292 U.S. 435section 7491 may shift the burden of proof in specified circumstances, petitioners did not argue, and in any event have not established, that they meet the prerequisites, undersection 7491(a)(1) and(2) , for such a shift.I. Bad Debt Deduction An individual taxpayer is entitled to a deduction for a debt, business or nonbusiness, that becomes wholly worthless2014 Tax Ct. Memo LEXIS 173">*181 during the taxable year.
See sec. 166(a)(1) ;sec. 1.166-5(a)(2), Income Tax Regs. The distinction between a business bad debt and a nonbusiness bad debt is important because business bad debts offset ordinary income dollar for dollar,see sec. 166(a) ,(d)(1)(A) , while a *185 nonbusiness bad debt is treated as a loss arising from the sale or exchange of a capital asset held for not more than one year,see sec. 166(d)(1)(B) ;sec. 1.166-5(a)(2), Income Tax Regs. The distinction between business and nonbusiness bad debt matters for a second reason, as well. For an individual taxpayer, a deduction may also be allowed for a business bad debt that is only partially worthless, to the extent it is charged off during the taxable year.
Sec. 166(a)(2) ,(d)(1) . Business debts are defined insection 166(d)(2) as those "created or acquired * * * in connection with a trade or business of the taxpayer" or "a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business." Petitioners' evidence does not show that the debt at issue here is a business debt. Rather, they were merely investors in Mortgage Co. Therefore, the debt was a nonbusiness debt.See Whipple v. Comm'r , 373 U.S. 193">373 U.S. 193Because petitioners' loan to Mortgage Co. was a nonbusiness debt, petitioners must establish that the debt was wholly "worthless" within the meaning of
section 166 as of the close of 2006, in2014 Tax Ct. Memo LEXIS 173">*182 order to be entitled to a deduction for that year. There is no standard test for determining worthlessness; whether and when a debt becomes worthless depends on all the facts and circumstances.Dallmeyer v. Commissioner , 14 T.C. 1282">14 T.C. 1282Crown v. Commissioner , 77 T.C. 582">77 T.C. 582See Andrew v. Commissioner , 54 T.C. 239">54 T.C. 239On November 17, 2006, petitioners filed a proof of claim in the bankruptcy court against Mortgage Co. "A proof of claim is a written statement setting forth a creditor's claim."
Fed. R. Bankr. P. 3001(a) . An executed proof of claim that is correctly filed constitutes prima facie evidence of the validity and amount of the claim.Id .para. (f) . Once a creditor files a proof of claim and the claim is accepted, or "allowed" by the bankruptcy court, the creditor becomes entitled to participate in any distribution from the2014 Tax Ct. Memo LEXIS 173">*183 bankruptcy estate, to the extent of that creditor's rights relative to those of other creditors in the bankruptcy.See 11 U.S.C secs. 502(a) ,726(a) (2012) (providing that creditor's claim, proof of which is filed, is deemed allowed absent objection by a party in interest, and for distribution of bankruptcy estate in payment of allowed claims). Petitioners allege *187 they filed the proof of claim in order to "prove * * * [their] loss and get tax refunds."Even if we were to accept that the proof of claim established the amount of petitioners' loss, the document does not establish that petitioners had no hope of recovery in 2006. On the contrary, it tends to establish the reverse: By filing a proof of claim in Mortgage Co.'s bankruptcy, petitioners took the requisite step to secure a place in the order of distribution from the bankruptcy estate and thereby increased their odds of recovering at least some of the loaned funds.
Moreover, in 2006 there was no clear indication of what Mortgage Co.'s assets and liabilities were. Mortgage Co. asserted that it had excess assets, and the truth or falsity of this assertion was neither revealed in the bankruptcy proceeding nor otherwise known to petitioners until after 2006. Further,2014 Tax Ct. Memo LEXIS 173">*184 as of the end of 2006, the bankruptcy court had yet to allow or disallow petitioners' claim, so they could not know definitively what portion of their loss, if any, might be satisfied from the bankruptcy estate. Hence, the information reasonably obtainable by petitioners indicated they had some hope of at least a partial recovery as of December 31, 2006. That hope would not have been vain. Three years later, the bankruptcy court authorized partial repayment of unsecured creditors like petitioners by way of two interim distributions.
*188 Accordingly, petitioners are not entitled to deduct a bad debt loss for 2006 because they could not establish, by the end of the 2006 tax year, the amount of their loan that they were not going to recover from Mortgage Co.
II. The Theft Loss Deduction Section 165(a) permits a deduction against ordinary income for "any loss sustained during the taxable year and not compensated for by insurance or otherwise." For individuals, the deduction is limited to: "(1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) * * * losses of property not connected with a trade or business2014 Tax Ct. Memo LEXIS 173">*185 or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft."Sec. 165(c) .A taxpayer who, like petitioners, claims a loss deduction due to theft pursuant to
section 165(c)(3) must prove two elements to properly substantiate a deduction. First, the taxpayer must prove that the loss is attributable to a theft that was established as such in the year for which the deduction is claimed. And second, becausesection 165(a) allows the deduction for the year in which a loss is "sustained", the taxpayer must demonstrate that the loss was incurred in the year for which the deduction is claimed. Petitioners have not proven that--as of *189 December 31, 2006--because of a theft, they had no hope of recovering any of the funds they had loaned to Mortgage Co.The term "theft" in
section 165(c)(3) is a word of general and broad meaning that includes any criminal appropriation of another's property, such as theft by swindling, false pretenses, and other forms of guile.Edwards v. Bromberg , 232 F.2d 107">232 F.2d 107sec. 1.165-8(d), Income Tax Regs. Whether a theft loss has been established depends upon the law of the State where the alleged theft occurred.Bellis v. Commissioner , 540 F.2d 448">540 F.2d 448aff'g 61 T.C. 354">61 T.C. 354 (1973);Luman v. Commissioner , 79 T.C. 846">79 T.C. 846Paine v. Commissioner , 63 T.C. 736">63 T.C. 736aff'd without published opinion ,523 F.2d 1053">523 F.2d 1053 (5th Cir. 1975). A taxpayer must prove a theft occurred under applicable State law by2014 Tax Ct. Memo LEXIS 173">*186 only a preponderance of the evidence.See Allen v. Commissioner , 16 T.C. 163">16 T.C. 163In 2009 Mr. Milanowski pleaded guilty to wire fraud; however, a criminal conviction is not necessary in order for a taxpayer to demonstrate a theft loss.
See Monteleone v. Commissioner , 34 T.C. 688">34 T.C. 688Even if the Court were to accept that petitioners could have proven Mr. Milanowski a thief in 2006, they would still need to prove that they "sustained" a theft loss in 2006. Generally, a theft loss is treated as sustained during the taxable year in which the taxpayer discovers it.2014 Tax Ct. Memo LEXIS 173">*187
Sec. 165(a) ,(e) . However, even after a theft loss is discovered, if a claim for reimbursement exists during the year of the loss with respect to which there is a reasonable prospect of at least some recovery, then a theft loss is treated as "sustained" only when it can be ascertained, with reasonable certainty, whether such reimbursement for the loss will be obtained and the amount thereof.Jeppsen v. Commissioner , 128 F.3d 1410">128 F.3d 1410aff'g T.C. Memo. 1995-342 ;2014 Tax Ct. Memo LEXIS 173">*188secs. 1.165-1(d)(2)(i) ,(3) ,1.165-8(a)(2) , *191 Income Tax Regs. Stated differently, a reasonable prospect of recovery will postpone the theft loss deduction until such time as the prospect no longer exists.2014 Tax Ct. Memo LEXIS 173">*189 *192 Petitioners have the burden of proving they have sustained a theft loss.See Rule 142(a) .Petitioners attempted to establish their loss by filing a proof of claim in Mortgage Co.'s bankruptcy proceeding. For the reasons explained above, petitioners have not shown that there was no reasonable prospect of recovery as of the end of the 2006 tax year. In fact, petitioners did recover at least some portion of their claimed loss, though the record does not clearly establish whether this recovery occurred in 2007 and/or in a subsequent year. Consequently, neither the amount of the bad debt nor the amount of the theft loss was established by December 31, 2006, and no deduction under either
section 165 orsection 166 is allowable for petitioners' 2006 tax year.We have considered all remaining arguments the parties made and, to the extent not addressed, we conclude they are irrelevant, moot, or meritless. *193 To reflect the foregoing,
Decision will be entered under 2014 Tax Ct. Memo LEXIS 173">*190 .Rule 155 Footnotes
1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the taxable year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure. We round all dollar amounts to the nearest dollar.↩
2. This amount is $4,044,096 reduced to reflect statutory limitations of $100 and 10% of adjusted gross income.
See sec. 165(c)(3) ,(h)↩ .3. A court may take judicial notice of appropriate adjudicative facts at any stage in a proceeding whether or not the parties request it.
See Fed. R. Evid. 201(c) ,(f) ;see also Nathan v. Boeing Co ., 116 F.3d 422">116 F.3d 422Fed. R. Evid. 201(b) .As we do here, a court may take judicial notice of pleadings and court orders filed in related proceedings.
See Asdar Group v. Pillsbury, Madison & Sutro , 99 F.3d 289">99 F.3d 289See, e.g., Marshek v. Eichenlaub , 266 Fed. Appx. 392">266 Fed. Appx. 392Denius v. Dunlap , 330 F.3d 919">330 F.3d 919Protect Lake Pleasant, LLC v. McDonald , 609 F. Supp. 2d 895">609 F. Supp. 2d 895Fed. R. Evid. 201(c) allows, the court will take judicial notice of * * * [that] website.").We emphasize, however, that we take judicial notice of the trustee's report only for the fact of its content, and not for the truth of that content. At trial, neither party introduced documentary evidence to substantiate whether Mr. and Mrs. Bunch in fact benefited from the interim distributions the trustee describes.↩
4. As the Court of Appeals for the Tenth Circuit explained:
Under the Internal Revenue Code, a theft loss is
not "sustained" at the time the theft actually occurs. Rather, "any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss."I.R.C. § 165(e) . Further, the Treasury Regulations provide that even after a theft loss is discovered, if a claim for reimbursement exists during the year of the loss with respect to which there is a reasonable prospect of recovery, then a theft loss is treated as "sustained" only when "it can be ascertained with reasonable certainty whether or not such reimbursement [for the loss] will be obtained."Treas. Reg. §§ 1.165-1(d)(2)(i) ,1.165-1(d)(3) ;accord Treas. Reg. § 1.165-8(a)(2) . In essence, this has been interpreted to mean that the existence of a claim of reimbursement with a reasonable prospect of recovery will prevent a loss from being considered as "sustained" unless and until it is determined with reasonable certainty that such reimbursement will not be obtained.See, e.g., Rainbow Inn, Inc. v. Commissioner , 433 F.2d 640">433 F.2d 640Jeppsen v. Commissioner , 128 F.3d 1410">128 F.3d 1410aff'g T.C. Memo. 1995-342↩ .5. Petitioners specifically sought to deduct a theft loss pursuant to
sec. 165(c)(3) , butsec. 165(c) has two additional paragraphs. As we have concluded,see supra p. 9, petitioners' loan to Mortgage Co. was not connected to a trade or business, sosec. 165(c)(1) would not apply. Because they made the loan as an investment, a transaction entered into for profit unconnected with a trade or business,sec. 165(c)(2) could potentially apply. To deduct their loss pursuant to that provision, however, petitioners would still be obliged to establish that they sustained the loss in 2006.See sec. 165(a) . To do so, they would need to show that the loss was "fixed by identifiable events occurring in" 2006.Sec. 1.165-1(d)(1), Income Tax Regs. However, as with a theft loss, where "there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery," no portion of a loss claimed pursuant tosec. 165(c)(2) is treated as having been sustained "until it can be ascertained with reasonable certainty whether or not such reimbursement will be received."Sec. 1.165-1(d)(2)(i), Income Tax Regs. Had petitioners sought to deduct their loss for the 2006 taxable year pursuant tosec. 165(c)(2) rather thansec. 165(c)(3)↩ , we would accordingly follow a similar analysis.
Document Info
Docket Number： Docket No. 18774-11.
Citation Numbers： 108 T.C.M. 226, 108 Tax Ct. Mem. Dec. (CCH) 226, 2014 Tax Ct. Memo LEXIS 173, 2014 T.C. Memo. 177
Judges： WHERRY
Filed Date： 8/28/2014
Precedential Status： Non-Precedential
Modified Date： 4/17/2021