Marvin DeBough v. Douglas Shulman, Comm. IRS

United States Court of Appeals
For the Eighth Circuit
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No. 14-3036
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Marvin E. DeBough
lllllllllllllllllllllAppellant
v.
Douglas Shulman, Commissioner of Internal Revenue
lllllllllllllllllllllAppellee
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The United States Tax Court
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Submitted: June 9, 2015
Filed: August 28, 2015
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Before LOKEN, BYE, and KELLY, Circuit Judges.
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KELLY, Circuit Judge.
In 1966, Marvin DeBough purchased a residence and surrounding 80 acres of
mixed-use land in Delano, Minnesota (the property) for $25,000. On July 11, 2006,
DeBough agreed to sell the property for $1.4 million to Stonehawk Corporation and
Catherine Constantine Properties, Inc. (the buyers) pursuant to an installment
contract. The buyers’ indebtedness was secured by the property.
Because the property was his principal residence, DeBough excluded $500,000
of gain from income on his 2006 tax return pursuant to 26 U.S.C. § 121 (the
principal-residence exclusion). This left taxable income of $157,796 on the sale of
the property. DeBough reported this income as installment sale income, beginning
in 2006. DeBough received a total of $505,000 from the buyers and reported a total
of $56,920 as taxable installment sale income for tax years 2006, 2007, and 2008.
In 2009, the buyers defaulted and DeBough reacquired the property, incurring
$3,723 in costs related to the reacquisition. DeBough kept the $505,000 he had
previously received from the buyers as liquidated damages. On his 2009 tax return,
DeBough treated this event as a reacquisition of property in full satisfaction of
indebtedness under 26 U.S.C. § 1038.1 In calculating his realized gain on the
reacquisition, DeBough again applied the $500,000 principal-residence exclusion.
DeBough reported $97,153 as long-term capital gains related to the reacquisition of
the property for tax year 2009. DeBough did not resell the property.
In 2012, the Commissioner sent DeBough a notice of deficiency with respect
to his 2009 tax return. The Commissioner determined DeBough had underreported
$448,080 in long-term capital gain for tax year 2009 by applying the
principal-residence exclusion in his calculation of gain. DeBough filed a petition
with the Tax Court, seeking a redetermination of the deficiency for tax year 2009.
The Tax Court2 agreed with the Commissioner, finding DeBough was not entitled to
the principal-residence exclusion because he had not resold the property within one
year. DeBough timely appealed. We affirm.3
1
26 U.S.C. § 1038 provides rules for calculating gain with respect to certain
reacquisitions of property.
2
The Honorable Joseph W. Nega, United States Tax Court Judge.
3
We have jurisdiction under 26 U.S.C. § 7482.
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I. Discussion
DeBough asserts that the Tax Court erred by not allowing him to claim the
$500,000 principal-residence exclusion when he reacquired the property in 2009. In
support of reversal, he contends that the Tax Court’s interpretation of § 1038 is
contrary to the intent of Congress and produces an unduly harsh result. This case of
first impression requires us to construe the relationship between §§ 121 and 1038 of
the tax code.
In reviewing Tax Court decisions, we review legal questions and mixed
questions of law and fact de novo. Clajon Gas Co., L.P. v. Commissioner, 354 F.3d
786, 789 (8th Cir. 2004). The Tax Court’s factual findings are reviewed under a
clearly erroneous standard. Id. In interpreting statutes, we rely on traditional rules
of statutory interpretation. POM Wonderful LLC v. Coca-Cola Co., — U.S. —, 134
S. Ct. 2228, 2236 (2014). “Analysis of the statutory text, aided by established
principles of interpretation, controls.” Id.
It has long been held that any “accessions to wealth, clearly recognized, and
over which the taxpayers have complete dominion,” usually are included in gross
income. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). Gain from
the sale of real property is generally calculated as the amount by which the sales price
of the property exceeds the seller’s adjusted basis in the property. 26 U.S.C.
§ 1001(a). However, if the real property is the taxpayer’s principal residence, a
married seller filing a joint return may exclude up to $500,000 of gain from the sale.
26 U.S.C. § 121(a), (b)(2).
One of the risks of selling real property on installment, as DeBough did with
his principal residence, is that a buyer may default. Prior to 1964, a taxpayer who
reacquired real property on default was required to recognize gain upon reacquisition
at the fair market value of the property when it was reacquired. This rule was often
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difficult to apply and sometimes unfair to the taxpayer,
because (1) the taxpayer was actually in no better position than he was
before he made the sale; (2) valuation at the time of repossession was
difficult; (3) to tax the initial seller on gain at the time of repossession
was to tax him on gain not yet realized; and (4) because the taxpayer had
not received a monetary return with respect to the property, funds to pay
the taxes may be unavailable.
Conners v. Commissioner, 88 T.C. 541, 544–45 (1987) (citing S. Rep. 88–1361
(1964)). For these reasons, Congress added § 1038 to the tax code, providing specific
rules for computing gain when a seller reacquires real property in satisfaction of a
debt secured by that property. See id.
The parties agree that § 1038 applies in this case, because DeBough reacquired
the property in full satisfaction of the buyers’ debt after the buyers defaulted. Section
1038 reads in part as follows:
(a) General rule.—If—
(1) a sale of real property gives rise to indebtedness to the
seller which is secured by the real property sold, and
(2) the seller of such property reacquires such property in
partial or full satisfaction of such indebtedness,
then, except as provided in subsections (b) and (d), no gain
or loss shall result to the seller from such reacquisition, and
no debt shall become worthless or partially worthless as a
result of such reacquisition.
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(b) Amount of gain resulting.—
(1) In general.—In the case of a reacquisition of real
property to which subsection (a) applies, gain shall result
from such reacquisition to the extent that—
(A) the amount of money and the fair market
value of other property (other than obligations
of the purchaser) received, prior to such
reacquisition, with respect to the sale of such
property, exceeds
(B) the amount of the gain on the sale of such
property returned as income for periods prior
to such reacquisition.
Thus, a taxpayer may disregard gain associated with the reacquisition of property,
except to the extent that the taxpayer received money from the sale of the property
prior to the reacquisition that is more than “the amount of gain on the sale” that was
“returned as income” in any tax period prior to the reacquisition. 26 U.S.C.
§ 1038(b)(1)(B). Here, for example, the parties agree that DeBough received
$505,000 from the sale of the property prior to reacquiring the property and claimed
$56,920 in gain on the tax returns he filed prior to reacquiring the property.
Calculating DeBough’s gain, the Commissioner asserts, is simply a matter of
subtracting $56,920 from $505,000.
Section 1038 provides a limited exception to the general rule for calculating
gain when the reacquired property was originally sold as the taxpayer’s principal
residence: If a taxpayer reacquires property that was his principal residence, but then
resells that property within one year, § 1038(e) allows the taxpayer to continue to
apply the principal-residence exclusion when calculating taxable gain. This section
states:
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(e) Principal residences.—If—
(1) subsection (a) applies to a reacquisition of real property
with respect to the sale of which gain was not recognized
under section 121 (relating to gain on sale of principal
residence); and
(2) within 1 year after the date of the reacquisition of such
property by the seller, such property is resold by him,
then, under regulations prescribed by the Secretary,
subsections (b), (c), and (d) of this section shall not apply
to the reacquisition of such property and, for purposes of
applying section 121, the resale of such property shall be
treated as a part of the transaction constituting the original
sale of such property.
26 U.S.C. § 1038(e). The Tax Court concluded that the § 1038(e) exception did not
apply to DeBough because he did not resell the property within one year. As a result,
the general rules applicable to reacquisitions of real property as outlined in § 1038(b)
acted to override the principal-residence exclusion, and the prior status of the
property as a principal residence was no longer relevant for tax purposes.
DeBough agrees that, because he did not resell the property within a year of
reacquisition, § 1038(e) does not apply. He asserts, however, that the Tax Code is
“silent on the question” of whether the principal-residence exclusion nevertheless
remains available even when a reacquired principal residence is not resold within one
year. He argues there is nothing in § 1038 that requires a taxpayer to recognize gain
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that was previously excluded under § 121.4 He argues the Tax Court’s interpretation
is counter to Congressional intent and renders an unduly harsh result based solely on
the timing of the resale of a principal residence.
“Our analysis begins, as always, with the statutory text.” Argus Leader Media
v. U.S. Dept. of Agric., 740 F.3d 1172, 1175 (8th Cir. 2014) (quoting United States
v. Gonzales, 520 U.S. 1, 4 (1997)). Section 1038(b)(1) requires a taxpayer to
recognize gain upon the reacquisition of property to the extent that the amount of
money the taxpayer received prior to the reacquisition exceeds the “amount of the
gain . . . returned as income” in prior years. 26 U.S.C. § 1038(b)(1) (emphasis
added). Put another way, we read § 1038(b) as acknowledging two types of gain
upon reacquisition of real property: gain that was “returned as income”—that is,
reported as income on a prior tax return—and gain that has not yet been “returned as
income.” On his 2006, 2007, and 2008 tax returns, DeBough reported gain totaling
$56,920–i.e., he “returned” $56,920 “as income.”
Section 121(a), on the other hand, states that “[g]ross income shall not include
gain from the sale . . . [of a] taxpayer’s principal residence.” 26 U.S.C. § 121(a). “In
the case of a husband and wife who make a joint return for the taxable year of the
sale . . . of the property,” gain of $500,000 can be excluded from gross income. 26
U.S.C. § 121(b). The principal-residence exclusion is, as the name indicates,
excluded from income. Having been excluded from income in 2006, the $500,000
principal-residence exclusion cannot be considered gain that was “returned as
income” on a prior tax return.
4
He contends the Tax Court’s holding effectively rewrites § 1038(b)(1)(B) from
“the amount of the gain . . . returned as income” to “the amount of the recognized
gain . . . returned as income” for periods prior to reacquisition.
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That Congress added § 1038(e) to the statute also supports the Tax Court’s
conclusion in this case. If a taxpayer reacquires a principal residence, but resells it
“within 1 year after the date of the reacquisition,” the general rule in § 1038(b) for
calculating gain on a reacquisition does not apply. 26 U.S.C. § 1038(e). “[F]or
purposes of applying section 121 [the principal-residence exclusion], the resale of
such property shall be treated as a part of the transaction constituting the original sale
of such property.” Id. DeBough asserts that silence on the question means the
principal-residence exclusion is available regardless of when the reacquired property
is resold. But if DeBough is right, then the § 1038(e) exception for reacquisition of
a principal residence that is sold within one year is completely unnecessary. It is a
settled rule of statutory construction that “we must, if possible, construe a statute to
give every word some operative effect.” Cooper Indus., Inc. v. Aviall Servs., Inc.,
543 U.S. 157, 167 (2004). Section 1038(e) has no “operative effect” if a taxpayer
may claim the principal-residence exclusion regardless of whether, upon
reacquisition, he resold the property within one year, resold it after more than one
year had passed, or never resold the property. We decline to render part of a statute
entirely superfluous. See Knight v. Commissioner, 552 U.S. 181, 190 (2008).
Finally, although we recognize that “the authoritative statement is the statutory
text, not the legislative history,” Argus Leader, 740 F.3d at 1177 (quoting Exxon
Mobil Corp. v. Allapattah Servs., Inc., 545 U.S. 546, 568 (2005)), we note that the
legislative history to § 1038 likewise supports our construction of the statute. In
enacting § 1038, Congress provided “[a] special rule . . . where the initial sale is that
of the taxpayer’s principal residence and the taxpayer has not recognized the gain (or
part of the gain)” because the gain was previously excluded under § 121. See S. Rep.
No. 88-1361, at 7 (emphasis added). Congress provided that
In such cases where the taxpayer resells the property within 1 year after
the repossession, no gain results at the time of repossession and the
initial sale and resale are treated as one transaction where the gain
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ordinarily would be limited because a second residence has been
purchased or no gain would be recognized because the taxpayer is over
age 65. This treatment in effect ignores the repossession in these cases
where the residence is again sold in a reasonable time.
Id. Congress intended that § 1038(e) apply to those taxpayers who resell a principal
residence within “a reasonable time,” i.e. one year. Section 1038(b) applies to all
other reacquisitions of real property— regardless of whether the real property ever
qualified as a principal residence. See Andrus v. Glover Constr. Co., 446 U.S. 608,
616–17 (1980). (“Where Congress explicitly enumerates certain exceptions to a
general prohibition, additional exceptions are not to be implied, in the absence of
evidence of a contrary legislative intent.”). DeBough has failed to show that limiting
this “special rule” to only those taxpayers who resell a principal residence within one
year of reacquisition is an unduly harsh one.5
We affirm the decision of the Tax Court.
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5
As to this particular case, we note, as the government did at oral argument,
that the gain DeBough must recognize as a result of the reacquisition is added to his
basis in the property, giving him a stepped-up basis should he again sell the property.
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