U.S. Supreme Court Malat v. Riddell, 383
U.S. 569 (1966) Malat v. Riddell No. 47 Argued March 3, 1966 Decided March 21,
1966 383
U.S. 569 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE NINTH
CIRCUIT Syllabus Upon the sale of real estate which had been acquired by a joint
venture in which petitioners participated, petitioners reported the
profits therefrom as capital gains. Respondent argued that the
venture had a dual purpose -- to develop the property for rental or
to sell it -- and that the profit was taxable as ordinary income.
The District Court ruled that petitioners failed to establish that
the property was not held primarily for sale to customers in the
ordinary course of business, and that the profits were not capital
gains under 26 U.S.C. § 1221(1). The Court of Appeals affirmed.
Respondent urges the construction of "primarily" as meaning that a
purpose may be "primary" if it is a "substantial" one. Held: The word "primarily," as used in §1221(1), means
"of first importance," or "principally."

															347 F.2d 23, vacated and remanded.

															PER CURIAM.

															Petitioner [ Footnote 1 ] was
a participant in a joint venture which acquired a 45-acre parcel of
land, the intended use for which is somewhat in dispute. Petitioner
contends that the venturers' intention was to develop and operate
an apartment project on the land; the respondent's position Page 383 U. S. 570 is that there was a "dual purpose" of developing the property
for rental purposes or selling, whichever proved to be the more
profitable. In any event, difficulties in obtaining the necessary
financing were encountered, and the interior lots of the tract were
subdivided and sold. The profit from those sales was reported and
taxed as ordinary income.

															The joint venturers continued to explore the possibility of
commercially developing the remaining exterior parcels. Additional
frustrations in the form of zoning restrictions were encountered.
These difficulties persuaded petitioner and another of the joint
venturers of the desirability of terminating the venture;
accordingly, they sold out their interests in the remaining
property. Petitioner contends that he is entitled to treat the
profits from this last sale as capital gains; the respondent takes
the position that this was "property held by the taxpayer primarily
for sale to customers in the ordinary course of his trade or
business," [ Footnote 2 ] and
thus subject to taxation as ordinary income.

															The District Court made the following finding:

															"The members of [the joint venture], as of the date the 44.901
acres were acquired, intended either to sell the property or
develop it for rental, depending upon which course appeared to be
most profitable. The venturers realized that they had made a good
purchase price-wise, and, if they were unable to obtain acceptable
construction financing or rezoning . . . which would be
prerequisite to commercial development, they would sell the
property Page 383 U. S. 571 in bulk so they wouldn't get hurt. The purpose of either selling
or developing the property continued during the period in which
[the joint venture] held the property."

															The District Court ruled that petitioner had failed to establish
that the property was not held primarily for sale to customers in
the ordinary course of business, and thus rejected petitioner's
claim to capital gain treatment for the profits derived from the
property's resale. The Court of Appeals affirmed, 347 F.2d 23. We
granted certiorari (382 U.S. 900) to resolve a conflict among the
courts of appeals [ Footnote 3 ]
with regard to the meaning of the term "primarily" as it is used in
§ 1221(1) of the Internal Revenue Code of 1954.

															The statute denies capital gain treatment to profits reaped from
the sale of "property held by the taxpayer primarily for
sale to customers in the ordinary course of his trade or business."
(Emphasis added.) The respondent urges upon us a construction of
"primarily" as meaning that a purpose may be "primary" if it is a
"substantial" one.

															As we have often said, "the words of statutes -- including
revenue acts -- should be interpreted where possible in their
ordinary, everyday senses." Crane v. Commissioner, 331 U. S. 1 , 331 U. S. 6 . And see Hanover Bank v. Commissioner, 369 U.
S. 672 , 369 U. S.
687 -688; Commissioner v. Korell, 339 U.
S. 619 , 339 U. S.
627 -628. Departure from a literal reading of statutory
language may, on occasion, be indicated by relevant internal
evidence of the statute itself Page 383 U. S. 572 and necessary in order to effect the legislative purpose. See, e.g., Board of Governors v. Agnew, 329 U.
S. 441 , 329 U. S.
446 -448. But this is not such an occasion. The purpose
of the statutory provision with which we deal is to differentiate
between the "profits and losses arising from the everyday operation
of a business," on the one hand ( Corn Products Refining Co. v.
Commissioner, 350 U. S. 46 , 350 U. S. 52 )
and "the realization of appreciation in value accrued over a
substantial period of time," on the other. ( Commissioner v.
Gillette Motor Transport, Inc., 364 U.
S. 130 , 364 U. S.
134 .) A literal reading of the statute is consistent
with this legislative purpose. We hold that, as used in § 1221(1),
"primarily" means "of first importance" or "principally."

															Since the courts below applied an incorrect legal standard, we
do not consider whether the result would be supportable on the
facts of this case had the correct one been applied. We believe,
moreover, that the appropriate disposition is to remand the case to
the District Court for fresh factfindings addressed to the statute
as we have now construed it. Vacated and remanded. MR. JUSTICE BLACK would affirm the judgments of the District
Court and the Court of Appeals.

															MR. JUSTICE WHITE took no part in the decision of this case.

															[ Footnote 1 ]

															The taxpayer and his wife, who filed a joint return, are the
petitioners, but, for simplicity, are referred to throughout as
"petitioner."

															[ Footnote 2 ]

															Internal Revenue Code of 1954, § 1221(1), 26 U.S.C. §
1221(1):

															"For purposes of this subtitle, the term 'capital asset' means
property held by the taxpayer (whether or not connected with his
trade or business), but does not include --"

															"(1) . . . property held by the taxpayer primarily for sale to
customers in the ordinary course of his trade or business."

															[ Footnote 3 ] Compare Rollingwood Corp. v. Commissioner, 190 F.2d
263, 266 (C.A.9th Cir.); American Can Co. v. Commissioner, 317 F.2d 604, 605 (C.A.2d Cir.), with United States v.
Bennett, 186 F.2d 407, 410-411 (C.A.5th Cir.); Municipal
Bond Corp. v. Commissioner, 341 F.2d 683, 688-689 (C.A.8th
Cir.). Cf. Recordak Corp. v. United States, 325 F.2d 460,
463-464, 163 Ct.Cl. 294, 300-301.

Summary: The Supreme Court remanded the case to the District Court, holding that the word "primarily" in 26 U.S.C. § 1221(1) means "of first importance" or "principally." The Court found that the District Court applied an incorrect legal standard and should reconsider the case using the correct interpretation of "primarily."


U.S. Supreme Court Diedrich v. Commissioner, 457
U.S. 191 (1982) Diedrich v.
Commissioner No. 80-2204 Argued February 24,
1982 Decided June 15, 1982 457
U.S. 191 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE EIGHTH CIRCUIT Syllabus Held: A donor (such as petitioner husband and wife and
petitioner executor's decedent) who makes a gift of property on
condition that the donee pay the resulting gift taxes realizes
taxable income to the extent that the gift taxes paid by the donee
exceed the donor's adjusted basis in the property. Pp. 457 U. S.
194 -200.

															(a) The substance, not the form, of the agreed transaction
controls in determining whether taxable income was realized. Old Colony Trust Co. v. Commissioner, 279 U.
S. 716 ; Crane v. Commissioner, 331 U. S.
1 . Pp. 457 U. S.
194 -196.

															(b) When a donor makes a gift, he incurs a "debt" to the United
States for the amount of whatever gift taxes are due, which are as
much the donor's legal obligation as his income taxes. When
conditional gifts, such as those in question here, are made, the
donor realizes an immediate economic benefit by the donee's
assumption of the donor's legal obligation to pay the gift taxes.
Subjective intent, while relevant in determining whether a gift has
been made, is not characteristically a factor in determining
whether an individual has realized income. Even if intent were a
factor, the donor's intent as to the condition shifting the gift
tax obligation to the donee is plainly to relieve the donor of the
debt owed to the United States. And the economic benefit realized
by the donor is not diminished by the fact that the liability
attaches during the course of the donative transfer, such benefit
being indistinguishable from the benefit arising from discharge of
a preexisting obligation. Pp. 457 U. S.
196 -198.

															(c) Treating the amount by which the gift taxes exceed the
donor's adjusted basis in the property as income is consistent with
§ 1001 of the Internal Revenue Code, which provides that the gain
from the disposition of property is the excess of the amount
realized over the transferor's adjusted basis in the property. Pp. 457 U. S.
198 -199.

															643 F.2d 499, affirmed.

															BURGER, C.J., delivered the opinion of the Court, in which
BRENNAN, WHITE, MARSHALL, BLACKMUN, POWELL, STEVENS, and O'CONNOR,
JJ., joined. REHNQUIST, J., filed a dissenting opinion, post, p. 457 U. S.
200 . Page 457 U. S. 192 CHIEF JUSTICE BURGER delivered the opinion of the Court.

															We granted certiorari to resolve a Circuit conflict as to
whether a donor who makes a gift of property on condition that the
donee pay the resulting gift tax receives taxable income to the
extent that the gift tax paid by the donee exceeds the donor's
adjusted basis in the property transferred. 454 U.S. 813 (1981).
The United States Court of Appeals for the Eighth Circuit held that
the donor realized income. 643 F.2d 499 (1981). We affirm. I A Diedrich v. Commissioner of Internal
Revenue In 1972, petitioners Victor and Frances Diedrich made gifts of
approximately 85,000 shares of stock to their three children, using
both a direct transfer and a trust arrangement. The gifts were
subject to a condition that the donees pay the resulting federal
and state gift taxes. There is no dispute concerning the amount of
the gift tax paid by the donees. The donors' basis in the
transferred stock was $51,073; the gift tax paid in 1972 by the
donees was $62,992. Petitioners did not include as income on their
1972 federal income tax returns any portion of the gift tax paid by
the donees. After Page 457 U. S. 193 an audit, the Commissioner of Internal Revenue determined that
petitioners had realized income to the extent that the gift tax
owed by petitioners, but paid by the donees, exceeded the donors'
basis in the property. Accordingly, petitioners' taxable income for
1972 was increased by $5,959. [ Footnote 1 ] Petitioners filed a petition in the United
States Tax Court for redetermination of the deficiencies. The Tax
Court held for the taxpayers, concluding that no income had been
realized. 39 TC M 433 (1979). B United Missouri Bank of Kansas City v. Commissioner of Internal Revenue In 1970 and 1971, Mrs. Frances Grant gave 90,000 voting trust
certificates to her son on condition that he pay the resulting gift
tax. Mrs. Grant's basis in the stock was $8,742.60; the gift tax
paid by the donee was $232,620.09. As in Diedrch, there is
no dispute concerning the amount of the gift tax or the fact of its
payment by the donee pursuant to the condition.

															Like the Diedrichs, Mrs. Grant did not include as income on her
1970 or 1971 federal income tax returns any portion of the amount
of the gift tax owed by her but paid by the donee. After auditing
her returns, the Commissioner determined that the gift of stock to
her son was part gift and part sale, with the result that Mrs.
Grant realized income to the extent that the amount of the gift tax
exceeded the adjusted basis in the property. Accordingly, Mrs.
Grant's taxable income was increased by approximately $112,000.
[ Footnote 2 ] Mrs. Grant
filed Page 457 U. S. 194 a petition in the United States Tax Court for redetermination of
the deficiencies. The Tax Court held for the taxpayer, concluding
that no income had been realized. Grant v. Commissioner, 39 TCM 108 (1980). C The United States Court of Appeals for the Eighth Circuit
consolidated the two appeals and reversed, concluding that, "to the
extent the gift taxes paid by donees" exceeded the donors' adjusted
bases in the property transferred, "the donors realized taxable
income." 643 F.2d at 504. The Court of Appeals rejected the Tax
Court's conclusion that the taxpayers merely had made a "net gift"
of the difference between the fair market value of the transferred
property and the gift taxes paid by the donees. The court reasoned
that a donor receives a benefit when a donee discharges a donor's
legal obligation to pay gift taxes. The Court of Appeals agreed
with the Commissioner in rejecting the holding in Turner v.
Commissioner, 49 T.C. 356 (1968), aff'd per curiam, 410 F.2d 752 (CA6 1969), and its progeny, and adopted the approach
of Johnson v. Commissioner, 59 T.C. 791 (1973), aff'd, 495 F.2d 1079 (CA6), cert. denied, 419
U.S. 1040 (1974), and Estate of Levine v. Commissioner, 72
T.C. 780 (1979), aff'd, 634 F.2d 12 (CA2 1980). We granted
certiorari to resolve this conflict, and we affirm. II A Pursuant to its constitutional authority, Congress has defined
"gross income" as income "from whatever source derived," including
"[i]ncome from discharge of indebtedness." Page 457 U. S. 195 26 U.S.C. § 61(12). [ Footnote
3 ] This Court has recognized that "income" may be realized by a
variety of indirect means. In Old Colony Trust Co. v.
Commissioner, 279 U. S. 716 (1929), the Court held that payment of an employee's income taxes
by an employer constituted income to the employee. Speaking for the
Court, Chief Justice Taft concluded that

															"[t]he payment of the tax by the employe[r] was in consideration
of the services rendered by the employee, and was a gain derived by
the employee from his labor." Id. at 279 U. S. 729 .
The Court made clear that the substance, not the form, of the
agreed transaction controls. "The discharge by a third person of an
obligation to him is equivalent to receipt by the person taxed." Ibid. The employee, in other words, was placed in a better
position as a result of the employer's discharge of the employee's
legal obligation to pay the income taxes; the employee thus
received a gain subject to income tax.

															The holding in Old Colony was reaffirmed in Crane
v. Commissioner, 331 U. S. 1 (1947).
In Crane, the Court concluded that relief from the
obligation of a nonrecourse mortgage in which the value of the
property exceeded the value of the mortgage constituted income to
the taxpayer. The taxpayer in Crane acquired depreciable
property, an apartment building, subject to an unassumed mortgage.
The taxpayer later sold the apartment building, which was still
subject to the nonrecourse mortgage, for cash plus the buyer's
assumption Page 457 U. S. 196 of the mortgage. This Court held that the amount of the mortgage
was properly included in the amount realized on the sale, noting
that, if the taxpayer transfers subject to the mortgage,

															"the benefit to him is as real and substantial as if the
mortgage were discharged, or as if a personal debt in an equal
amount had been assumed by another." Id. at 331 U. S. 14 .
[ Footnote 4 ] Again, it was the
"reality," not the form, of the transaction that governed. Ibid. The Court found it immaterial whether the seller
received money prior to the sale in order to discharge the
mortgage, or whether the seller merely transferred the property
subject to the mortgage. In either case the taxpayer realized an
economic benefit. B The principles of Old Colony and Crane control. [ Footnote 5 ] A common
method of structuring gift transactions is for the donor Page 457 U. S. 197 to make the gift subject to the condition that the donee pay the
resulting gift tax, as was done in each of the cases now before us.
When a gift is made, the gift tax liability falls on the donor
under 26 U.S.C. § 2502(d). [ Footnote 6 ] When a donor makes a gift to a donee, a "debt"
to the United States for the amount of the gift tax is incurred by
the donor. Those taxes are as much the legal obligation of the
donor as the donor's income taxes; for these purposes, they are the
same kind of debt obligation as the income taxes of the employee in Old Colony, supra. Similarly, when a donee agrees to
discharge an indebtedness in consideration of the gift, the person
relieved of the tax liability realizes an economic benefit. In
short, the donor realizes an immediate economic benefit by the
donee's assumption of the donor's legal obligation to pay the gift
tax.

															An examination of the donor's intent does not change the
character of this benefit. Although intent is relevant in
determining whether a gift has been made, subjective intent has not
characteristically been a factor in determining whether an
individual has realized income. [ Footnote 7 ] Even if intent Page 457 U. S. 198 were a factor, the donor's intent with respect to the condition
shifting the gift tax obligation from the donor to the donee was
plainly to relieve the donor of a debt owed to the United States;
the choice was made because the donor would receive a benefit in
relief from the obligation to pay the gift tax. [ Footnote 8 ]

															Finally, the benefit realized by the taxpayer is not diminished
by the fact that the liability attaches during the course of a
donative transfer. It cannot be doubted that the donors were aware
that the gift tax obligation would arise immediately upon the
transfer of the property; the economic benefit to the donors in the
discharge of the gift tax liability is indistinguishable from the
benefit arising from discharge of a preexisting obligation. Nor is
there any doubt that, had the donors sold a portion of the stock
immediately before the gift transfer in order to raise funds to pay
the expected gift tax, a taxable gain would have been realized. 26
U.S.C. § 1001. The fact that the gift tax obligation was discharged
by way of a conditional gift, rather than from funds derived from a
pre-gift sale, does not alter the underlying benefit to the
donors. C Consistent with the economic reality, the Commissioner has
treated these conditional gifts as a discharge of indebtedness
through a part gift and part sale of the gift property transferred.
The transfer is treated as if the donor sells the property to the
donee for less than the fair market value. The "sale" price is the
amount necessary to discharge the gift Page 457 U. S. 199 tax indebtedness; the balance of the value of the transferred
property is treated as a gift. The gain thus derived by the donor
is the amount of the gift tax liability less the donor's adjusted
basis in the entire property. Accordingly, income is realized to
the extent that the gift tax exceeds the donor's adjusted basis in
the property. This treatment is consistent with § 1001 of the
Internal Revenue Code, which provides that the gain from the
disposition of property is the excess of the amount realized over
the transferor's adjusted basis in the property. [ Footnote 9 ] III We recognize that Congress has structured gift transactions to
encourage transfer of property by limiting the tax consequences of
a transfer. See, e.g., 26 U.S.C. § 102 (gifts excluded
from donee's gross income). Congress may obviously provide a
similar exclusion for the conditional gift. Should Congress wish to
encourage "net gifts," changes in the income tax consequences of
such gifts lie within the legislative responsibility. Until such
time, we are bound by Congress' mandate that gross income includes
income "from whatever source derived." We therefore hold that a
donor who makes a gift of property on condition that the donee pay
the resulting gift taxes realizes taxable income to the extent Page 457 U. S. 200 that the gift taxes paid by the donee exceed the donor's
adjusted basis in the property. [ Footnote 10 ]

															The judgment of the United States Court of Appeals for the
Eighth Circuit is Affirmed. [ Footnote 1 ]

															Subtracting the stock basis of $51,073 from the gift tax paid by
the donees of $62,992, the Commissioner found that petitioners had
realized a long-term capital gain of $11,919. After a 50% reduction
in long-term capita gain, 26 U.S.C. § 1202, the Diedrichs' taxable
income increased by $5,959.

															[ Footnote 2 ]

															The gift taxes were $232,630.09. Subtracting the adjusted basis
of $8,742.60, the Commissioner found that Mrs. Grant realized a
long-term capital gain of $223,887.49. After a 50% reduction for
long-term capital gain, 26 U.S.C. § 1202, Mrs. Grant's taxable
income increased by $111,943.75

															During pendency of this lawsuit, Mrs. Grant died and the United
Missouri Bank of Kansas City, the decedent's executor, was
substituted as petitioner.

															[ Footnote 3 ]

															The United States Constitution provides that Congress shall have
the power to lay and collect taxes on income "from whatever source
derived." Art. I, 8, cl. 1; Amdt. 16.

															In Helvering v. Bruun, 309 U.
S. 461 , 309 U. S. 469 (1940), the Court noted:

															"While it is true that economic gain is not always taxable as
income, it is settled that the realization of gain need not be in
cash derived from the sale of an asset. Gain may occur as a result
of exchange of property, payment of the taxpayer's
indebtedness, relief from a liability, or other profit
realized from the completion of a transaction."

															(Emphasis supplied.)

															[ Footnote 4 ]

															In Crane, the taxpayer received favorable tax treatment
for the loan and was allowed depreciation on the property. The
Court concluded that the taxpayer could not then later escape
taxation after having received these benefits when the loan
obligation was assumed by another.

															Whether income would have been realized in Crane if the
value of the property at the time of transfer had been less than
the amount of the mortgage need not be considered here. See
Crane, 331 U.S. at 331 U. S. 14 , n.
37.

															[ Footnote 5 ]

															Although the Commissioner has argued consistently that payment
of gift taxes by the donee results in income to the donor, several
courts have rejected this interpretation. See, e.g., Turner v.
Commissioner, 49 T.C. 356 (1968), aff'd per curiam, 410 F.2d 752 (CA6 1969); Hirst v. Commissioner, 572 F.2d
427 (CA4 1978) (en banc). Cf. Johnson v. Commissioner, 495
F.2d 1079 (CA6), cert. denied, 419 U.S. 1040 (1974).

															It should be noted that the gift tax consequences of a
conditional gift will be unaffected by the holding in this case.
When a conditional "net" gift is given, the gift tax attributable
to the transfer is to be deducted from the value of the property in
determining the value of the gift at the time of transfer. See Rev.Rul. 75-72, 1975-1 Cum.Bull. 310 (general formula
for computation of gift tax on conditional gift); Rev.Rul. 71-232,
1971-1 Cum.Bull. 275.

															[ Footnote 6 ]

															"The tax imposed by section 2501 shall be paid by the
donor."

															Section 6321 imposes a lien on the personal property of the
donor when a tax is not paid when due. The donee is secondarily
responsible for payment of the gift tax should the donor fail to
pay the tax. 26 U.S.C. § 6324(b). The donee's liability, however,
is limited to the value of the gift. Ibid. This
responsibility of the donee is analogous to a lien or security. Ibid. See also S.Rep. No. 665, 72d Cong., 1st
Sess., 42 (1932); H.R.Rep. No. 708, 72d Cong., 1st Sess., 30
(1932).

															[ Footnote 7 ]

															Several courts have found it highly significant that the donor
intended to make a gift. Turner v. Commissioner, supra; Hirst
v. Commissioner, supra. It is not enough, however, to state
that the donor intended simply to make a gift of the amount which
will remain after the donee pays the gift tax. As noted above,
subjective intent has not characteristically been a factor in
determining whether an individual has realized income. In Commissioner v. Duberstein, 363 U.
S. 278 , 363 U. S. 286 (1960), the Court noted that "the donor's characterization of his
action is not determinative." See also Minnesota Tea Co. v.
Helvering, 302 U. S. 609 , 302 U. S. 613 (1938) ("A given result at the end of a straight path is not made a
different result because reached by following a devious path").

															[ Footnote 8 ]

															The existence of the "condition" that the gift will be made only
if the donee assumes the gift tax consequences precludes any
characterization that the payment of the taxes was simply a gift
from the donee back to the donor.

															A conditional gift not only relieves the donor of the gift tax
liability, but also may enable the donor to transfer a larger sum
of money to the donee than would otherwise be possible due to such
factors as differing income tax brackets of the donor and
donee.

															[ Footnote 9 ]

															Section 1001 provides:

															"(a) Computation of gain or loss. -- 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."

															"(b) Amount realized. -- The amount realized from the
sale or other disposition of property shall be the sum of any money
received plus the fair market value of the property (other than
money) received. . . ."

															"By treating conditional gifts as a part gift and part sale,
income is realized only when highly appreciated property is
transferred, for only highly appreciated property will result in a
gift tax greater than the adjusted basis."

															[ Footnote 10 ]

															Petitioners argue that even if this Court holds that a donor
realizes income on a conditional gift to the extent that the gift
tax exceeds the adjusted basis, that holding should be applied
prospectively, and should not apply to the taxpayers in this case.
In this case, however, there was no dispositive Eighth Circuit
holding prior to the decision on review. In addition, this Court
frequently has applied decisions which have altered the tax law and
applied the clarified law to the facts of the case before it. See, e.g., United States v. Estate of Donnelly, 397 U. S. 286 , 397 U. S.
294 -295 (1970).

															JUSTICE REHNQUIST, dissenting.

															It is a well-settled principle today that a taxpayer realizes
income when another person relieves the taxpayer of a legal
obligation in connection with an otherwise taxable transaction. See Crane v. Commissioner, 331 U. S.
1 (1947) (sale of real property); Old Colony Trust
Co. v. Commissioner, 279 U. S. 716 (1929) (employment compensation). In neither Old Colony nor Crane was there any question as to the existence of a
taxable transaction; the only question concerned the amount of
income realized by the taxpayer as a result of the taxable
transaction. The Court in this case, however, begs the question of
whether a taxable transaction has taken place at all when it
concludes that "[t]he principles of Old Colony and Crane control" this case. Ante at 457 U. S.
196 .

															In Old Colony, the employer agreed to pay the
employee's federal tax liability as part of his compensation. The
employee provided his services to the employer in exchange for
compensation. The exchange of compensation for services was
undeniably a taxable transaction. The only question was whether the
employee's taxable income included the employer's assumption of the
employee's income tax liability.

															In Crane, the taxpayer sold real property for cash plus
the buyer's assumption of a mortgage. Clearly a sale had occurred,
and the only question was whether the amount of the Page 457 U. S. 201 mortgage assumed by the buyer should be included in the amount
realized by the taxpayer. The Court rejected the taxpayer's
contention that what she sold was not the property itself, but her
equity in that property.

															Unlike Old Colony or Crane, the question in
this case is not the amount of income the taxpayer has realized as
a result of a concededly taxable transaction, but whether a taxable
transaction has taken place at all. Only after one
concludes that a partial sale occurs when the donee agrees to pay
the gift tax do Old Colony and Crane become
relevant in ascertaining the amount of income realized by the donor
as a result of the transaction. Nowhere does the Court explain why
a gift becomes a partial sale merely because the donor and donee
structure the gift so that the gift tax imposed by Congress on the
transaction is paid by the donee, rather than the donor.

															In my view, the resolution of this case turns upon congressional
intent: whether Congress intended to characterize a gift as a
partial sale whenever the donee agrees to pay the gift tax.
Congress has determined that a gift should not be considered income
to the donee. 26 U.S.C. § 102. Instead, gift transactions are to be
subject to a tax system wholly separate and distinct from the
income tax. See 26 U.S.C. § 2501 et seq. Both the
donor and the donee may be held liable for the gift tax. §§
2502(d), 6324(b). Although the primary liability for the gift tax
is on the donor, the donee is liable to the extent of the value of
the gift should the donor fail to pay the tax. I see no evidence in
the tax statutes that Congress forbade the parties to agree among
themselves as to who would pay the gift tax upon pain of such an
agreement being considered a taxable event for the purposes of the
income tax. Although Congress could certainly determine that the
payment of the gift tax by the donee constitutes income to the
donor, the relevant statutes do not affirmatively indicate that
Congress has made such a determination.

															I dissent.

Summary: In *Diedrich v. Commissioner* (1982), the U.S. Supreme Court held that a donor who makes a gift on the condition that the recipient pays the resulting gift tax realizes taxable income if the gift tax paid by the recipient exceeds the donor's adjusted basis in the property. The Court determined that the substance of the transaction, rather than its form, controls whether taxable income was realized. When a donor makes a gift, they incur a "debt" for gift taxes, similar to income taxes. If the recipient assumes this debt by agreeing to pay the gift tax, the donor realizes an economic benefit, which is considered taxable income. This interpretation is consistent with the Internal Revenue Code's definition of gain from the disposition of property.


U.S. Supreme Court Commissioner v. Tufts, 461
U.S. 300 (1983) Commissioner v. Tufts No. 81-1536 Argued November 29,
1982 Decided May 2, 1983 461
U.S. 300 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE FIFTH CIRCUIT Syllabus Section 72(d) of the Internal Revenue Code of 1954 (IRC)
provides that liabilities involved in the sale or exchange of a
partnership interest are to be treated "in the same manner as
liabilities in connection with the sale or exchange of property not
associated with partnerships." Under § 1001(a) of the IRC, the gain
or loss from a sale or other disposition of property is defined as
the difference between "the amount realized" on the disposition and
the property's adjusted basis. Section 1001(b) defines the "amount
realized" as "the sum of any money received plus the fair market
value of the property (other than money) received." A general
partnership formed by respondents in 1970 to construct an apartment
complex entered into a $1,851,500 nonrecourse mortgage loan with a
savings association. The complex was completed in 1971. Due to the
partners' capital contributions to the partnership and income tax
deductions for their allocable shares of ordinary losses and
depreciation, the partnership's claimed adjusted basis in the
property in 1972 was $1,455,740. Because of an unanticipated
reduction in rental income, the partnership was unable to make the
payments due on the mortgage. Each partner thereupon sold his
interest to a third party, who assumed the mortgage. The fair
market value on the date of transfer did not exceed $1,400,000.
Each partner reported the sale on his income tax return and
indicated a partnership loss of $55,740. The Commissioner of
Internal Revenue, however, determined that the sale resulted in a
partnership gain of approximately $400,000 on the theory that the
partnership had realized the full amount of the nonrecourse
obligation. The United States Tax Court upheld the deficiencies,
but the Court of Appeals reversed. Held: When a taxpayer sells or disposes of property
encumbered by a nonrecourse obligation exceeding the fair market
value of the property sold, as in this case, the Commissioner may
require him to include in the "amount realized" the outstanding
amount of the obligation; the fair market value of the property is
irrelevant to this calculation. Cf. Crane v. Commissioner, 331 U. S. 1 . Pp. 461 U. S.
304 -317. Page 461 U. S. 301 (a) When the mortgagor's obligation to repay the mortgage loan
is canceled, he is relieved of his responsibility to repay the sum
he originally received, and thus realizes value to that extent
within the meaning of § 1001(b). To permit the taxpayer to limit
his realization to the fair market value of the property would be
to recognize a tax loss for which he has suffered no corresponding
economic loss. A taxpayer must account for the proceeds of
obligations he has received tax-free and has included in basis.
Nothing in either § 1001(b) or in this Court's prior decisions
requires the Commissioner to permit a taxpayer to treat a sale of
encumbered property asymmetrically, by including the proceeds of
the nonrecourse obligation in basis but not accounting for the
proceeds upon transfer of the property. Pp. 461 U. S.
304 -319.

															(b) Section 752(c) of the IRC -- which provides that, for
purposes of § 752,

															"a liability to which property is subject shall, to the extent
of the fair market value of such property, be considered as a
liability of the owner of the property"

															-- does not authorize this type of asymmetrical treatment in the
sale or disposition of partnership property. Rather, the
legislative history indicates that the fair market value limitation
of § 752(c) was intended to apply only to transactions between a
partner and his partnership under §§ 752(a) and (b), and was not
intended to limit the amount realized in a sale or exchange of a
partnership interest under § 752(d). Pp. 461 U. S.
314 -317.

															651 F.2d 1058, reversed.

															JUSTICE BLACKMUN delivered the opinion of the Court.

															Over 35 years ago, in Crane v. Commissioner, 331 U. S. 1 (1947),
this Court ruled that a taxpayer, who sold property encumbered by a
nonrecourse mortgage (the amount of the Page 461 U. S. 302 mortgage being less than the property's value), must include the
unpaid balance of the mortgage in the computation of the amount the
taxpayer realized on the sale. The case now before us presents the
question whether the same rule applies when the unpaid amount of
the nonrecourse mortgage exceeds the fair market value of the
property sold. I On August 1, 1970, respondent Clark Pelt, a builder, and his
wholly owned corporation, respondent Clark, Inc., formed a general
partnership. The purpose of the partnership was to construct a
120-unit apartment complex in Duncanville, Tex., a Dallas suburb.
Neither Pelt nor Clark, Inc., made any capital contribution to the
partnership. Six days later, the partnership entered into a
mortgage loan agreement with the Farm & Home Savings
Association (F&H). Under the agreement, F&H was committed
for a $1,851,500 loan for the complex. In return, the partnership
executed a note and a deed of trust in favor of F&H. The
partnership obtained the loan on a nonrecourse basis: neither the
partnership nor its partners assumed any personal liability for
repayment of the loan. Pelt later admitted four friends and
relatives, respondents Tufts, Steger, Stephens, and Austin, as
general partners. None of them contributed capital upon entering
the partnership.

															The construction of the complex was completed in August, 1971.
During 1971, each partner made small capital contributions to the
partnership; in 1972, however, only Pelt made a contribution. The
total of the partners' capital contributions was $44,212. In each
tax year, all partners claimed as income tax deductions their
allocable shares of ordinary losses and depreciation. The
deductions taken by the partners in 1971 and 1972 totalled
$439,972. Due to these contributions and deductions, the
partnership's adjusted basis in the property in August, 1972, was
$1,455,740. Page 461 U. S. 303 In 1971 and 1972, major employers in the Duncanville area laid
off significant numbers of workers. As a result, the partnership's
rental income was less than expected, and it was unable to make the
payments due on the mortgage. Each partner, on August 28, 1972,
sold his partnership interest to an unrelated third party, Fred
Bayles. As consideration, Bayles agreed to reimburse each partner's
sale expenses up to $250; he also assumed the nonrecourse
mortgage.

															On the date of transfer, the fair market value of the property
did not exceed $1,400,000. Each partner reported the sale on his
federal income tax return and indicated that a partnership loss of
$55,740 had been sustained. [ Footnote 1 ] The Commissioner of Internal Revenue, on
audit, determined that the sale resulted in a partnership capital
gain of approximately $400,000. His theory was that the partnership
had realized the full amount of the nonrecourse obligation.
[ Footnote 2 ]

															Relying on Millar v. Commissioner, 577 F.2d 212, 215
(CA3), cert. denied, 439 U.S. 1046 (1978), the United
States Tax Court, in an unreviewed decision, upheld the asserted
deficiencies. 70 T.C. 756 (1978). The United States Court of
Appeals for the Fifth Circuit reversed. 651 F.2d 1058 (1981). That
court expressly disagreed with the Millar analysis, and,
in limiting Crane v. Commissioner, supra, to its facts,
questioned the theoretical underpinnings of the Crane Page 461 U. S. 304 decision. We granted certiorari to resolve the conflict. 456
U.S. 960 (1982). II Section 752(d) of the Internal Revenue Code of 1954, 26 U.S.C. §
752(d), specifically provides that liabilities involved in the sale
or exchange of a partnership interest are to "be treated in the
same manner as liabilities in connection with the sale or exchange
of property not associated with partnerships." Section 1001 governs
the determination of gains and losses on the disposition of
property. Under § 1001(a), the gain or loss from a sale or other
disposition of property is defined as the difference between "the
amount realized" on the disposition and the property's adjusted
basis. Subsection (b) of § 1001 defines "amount realized":

															"The amount realized from the sale or other disposition of
property shall be the sum of any money received plus the fair
market value of the property (other than money) received."

															At issue is the application of the latter provision to the
disposition of property encumbered by a nonrecourse mortgage of an
amount in excess of the property's fair market value. A In Crane v. Commissioner, supra, this Court took the
first and controlling step toward the resolution of this issue.
Beulah B. Crane was the sole beneficiary under the will of her
deceased husband. At his death in January, 1932, he owned an
apartment building that was then mortgaged for an amount which
proved to be equal to its fair market value, as determined for
federal estate tax purposes. The widow, of course, was not
personally liable on the mortgage. She operated the building for
nearly seven years, hoping to turn it into a profitable venture;
during that period, she claimed income tax deductions for
depreciation, property taxes, interest, and operating expenses, but
did not make payments upon the mortgage principal. In computing her
basis for the depreciation deductions, she included the full amount
of the Page 461 U. S. 305 mortgage debt. In November, 1938, with her hopes unfulfilled and
the mortgagee threatening foreclosure, Mrs. Crane sold the
building. The purchaser took the property subject to the mortgage
and paid Crane $3,000; of that amount, $500 went for the expenses
of the sale.

															Crane reported a gain of $2,500 on the transaction. She reasoned
that her basis in the property was zero (despite her earlier
depreciation deductions based on including the amount of the
mortgage) and that the amount she realized from the sale was simply
the cash she received. The Commissioner disputed this claim. He
asserted that Crane's basis in the property, under § 113(a)(5) of
the Revenue Act of 1938, 52 Stat. 490 (the current version is §
1014 of the 1954 Code, as amended, 26 U.S.C. § 1014 (1976 ed. and
Supp. V)), was the property's fair market value at the time of her
husband's death, adjusted for depreciation in the interim, and that
the amount realized was the net cash received plus the amount of
the outstanding mortgage assumed by the purchaser.

															In upholding the Commissioner's interpretation of § 113 (a)(5)
of the 1938 Act, [ Footnote 3 ]
the Court observed that to regard merely the taxpayer's equity in
the property as her basis would lead to depreciation deductions
less than the actual physical deterioration of the property, and
would require the basis to be recomputed with each payment on the
mortgage. 331 U.S. at 331 U. S. 9 -10.
The Court rejected Crane's claim that any loss due to depreciation
belonged to the mortgagee. The effect of the Court's ruling was
that the taxpayer's basis was the value of the property
undiminished by the mortgage. Id. at 331 U. S. 11 . Page 461 U. S. 306 The Court next proceeded to determine the amount realized under
§ 111(b) of the 1938 Act, 52 Stat. 484 (the current version is §
1001(b) of the 1954 Code, 26 U.S.C. § 1001(b)). In order to avoid
the "absurdity," see 331 U.S. at 331 U. S. 13 , of
Crane's realizing only $2,500 on the sale of property worth over a
quarter of a million dollars, the Court treated the amount realized
as it had treated basis, that is, by including the outstanding
value of the mortgage. To do otherwise would have permitted Crane
to recognize a tax loss unconnected with any actual economic loss.
The Court refused to construe one section of the Revenue Act so as
"to frustrate the Act as a whole." Ibid. Crane, however, insisted that the nonrecourse nature of the
mortgage required different treatment. The Court, for two reasons,
disagreed. First, excluding the nonrecourse debt from the amount
realized would result in the same absurdity and frustration of the
Code. Id. at 331 U. S. 13 -14.
Second, the Court concluded that Crane obtained an economic benefit
from the purchaser's assumption of the mortgage identical to the
benefit conferred by the cancellation of personal debt. Because the
value of the property in that case exceeded the amount of the
mortgage, it was in Crane's economic interest to treat the mortgage
as a personal obligation; only by so doing could she realize upon
sale the appreciation in her equity represented by the $2,500 boot.
The purchaser's assumption of the liability thus resulted in a
taxable economic benefit to her, just as if she had been given, in
addition to the boot, a sum of cash sufficient to satisfy the
mortgage. [ Footnote 4 ] Page 461 U. S. 307 In a footnote, pertinent to the present case, the Court
observed:

															"Obviously, if the value of the property is less than the amount
of the mortgage, a mortgagor who is not personally liable cannot
realize a benefit equal to the mortgage. Consequently, a different
problem might be encountered where a mortgagor abandoned the
property or transferred it subject to the mortgage without
receiving boot. That is not this case." Id. at 331 U. S. 14 , n.
37. B This case presents that unresolved issue. We are disinclined to
overrule Crane, and we conclude that the same rule applies
when the unpaid amount of the nonrecourse mortgage exceeds the
value of the property transferred. Crane ultimately does
not rest on its limited theory of economic benefit; instead, we
read Crane to have approved the Commissioner's decision to
treat a nonrecourse mortgage in this context as a true loan. This
approval underlies Crane's holdings that the amount of the
nonrecourse liability is to be included in calculating both the
basis and the amount realized on disposition. That the amount of
the loan exceeds the fair market value of the property thus becomes
irrelevant.

															When a taxpayer receives a loan, he incurs an obligation to
repay that loan at some future date. Because of this obligation,
the loan proceeds do not qualify as income to the taxpayer. When he
fulfills the obligation, the repayment of the loan likewise has no
effect on his tax liability.

															Another consequence to the taxpayer from this obligation occurs
when the taxpayer applies the loan proceeds to the purchase price
of property used to secure the loan. Because of the obligation to
repay, the taxpayer is entitled to include the amount of the loan
in computing his basis in the property; the loan, under § 1012, is
part of the taxpayer's cost of the Page 461 U. S. 308 property. Although a different approach might have been taken
with respect to a nonrecourse mortgage loan, [ Footnote 5 ] the Commissioner has chosen to accord
it the same treatment he gives to a recourse mortgage loan. The
Court approved that choice in Crane, and the respondents
do not challenge it here. The choice and its resultant benefits to
the taxpayer are predicated on the assumption that the mortgage
will be repaid in full.

															When encumbered property is sold or otherwise disposed of and
the purchaser assumes the mortgage, the associated Page 461 U. S. 309 extinguishment of the mortgagor's obligation to repay is
accounted for in the computation of the amount realized. [ Footnote 6 ] See United States v.
Hendler, 303 U. S. 564 , 303 U. S.
566 -567 (1938). Because no difference between recourse
and nonrecourse obligations is recognized in calculating basis,
[ Footnote 7 ] Crane teaches that the Commissioner may ignore the nonrecourse nature of
the obligation in determining the amount realized upon disposition
of t.he encumbered property. He thus may include in the amount
realized the amount of the nonrecourse mortgage assumed by the
purchaser. The rationale for this treatment is that the original
inclusion of the amount of the mortgage in basis rested on the
assumption that the mortgagor incurred an obligation to repay.
Moreover, this treatment balances the fact that the mortgagor
originally received the proceeds of the nonrecourse loan tax-free
on the same assumption. Page 461 U. S. 310 Unless the outstanding amount of the mortgage is deemed to be
realized, the mortgagor effectively will have received untaxed
income at the time the loan was extended, and will have received an
unwarranted increase in the basis of his property. [ Footnote 8 ] The Commissioner's interpretation
of § 1001(b) in this fashion cannot be said to be unreasonable. C The Commissioner, in fact, has applied this rule even when the
fair market value of the property falls below the amount of the
nonrecourse obligation. Treas.Reg. § 1.1001-2(b), 26 CFR §
1.1001-2(b) (1982); [ Footnote
9 ] Rev.Rul. 76-111, 1976-1 Cum.Bull. 214. Because the theory on
which the rule is based applies equally in this situation, see
Millar v. Commissioner, 67 T.C. 656, 660 (1977), aff'd on
this issue, 577 F.2d 212, 215-216 (CA3), cert.
denied, 439 U.S. 1046 (1978); [ Footnote 10 ] Mendham Corp. v. Commissioner, 9
T.C. 320, 323-324 (1947); Lutz & Schramm Co. v.
Commissioner, 1 T.C. 682, 688-689 (1943), we have no reason,
after Crane, to question this treatment. [ Footnote 11 ] Page 461 U. S. 311 Respondents received a mortgage loan with the concomitant
obligation to repay by the year 2012. The only difference between
that mortgage and one on which the borrower Page 461 U. S. 312 is personally liable is that the mortgagee's remedy is limited
to foreclosing on the securing property. This difference does not
alter the nature of the obligation; its only effect is to shift
from the borrower to the lender any potential loss caused by
devaluation of the property. [ Footnote 12 ] If the fair market value of the property
falls below the amount of the outstanding obligation, the
mortgagee's ability to protect its interests is impaired, for the
mortgagor is free to abandon the property to the mortgagee and be
relieved of his obligation.

															This, however, does not erase the fact that the mortgagor
received the loan proceeds tax-free, and included them in his basis
on the understanding that he had an obligation to repay the full
amount. See Woodsam Associates, Inc. v. Commissioner, 198
F.2d 357, 359 (CA2 1952); Bittker, supra, n 7, at 284. When the obligation is canceled,
the mortgagor is relieved of his responsibility to repay the sum he
originally received, and thus realizes value to that extent within
the meaning of § 1001(b). From the mortgagor's point of view, when
his obligation is assumed by a third party who purchases the
encumbered property, it is as if the mortgagor first had been paid
with cash borrowed by the third party from the mortgagee on a
nonrecourse basis, and then had used the cash to satisfy his
obligation to the mortgagee.

															Moreover, this approach avoids the absurdity the Court
recognized in Crane. Because of the remedy accompanying
the mortgage in the nonrecourse situation, the depreciation Page 461 U. S. 313 in the fair market value of the property is relevant
economically only to the mortgagee, who, by lending on a
nonrecourse basis, remains at risk. To permit the taxpayer to limit
his realization to the fair market value of the property would be
to recognize a tax loss for which he has suffered no corresponding
economic loss. [ Footnote 13 ]
Such a result would be to construe "one section of the Act . . . so
as . . . to defeat the intention of another or to frustrate the Act
as a whole." 331 U.S. at 331 U. S. 13 .

															In the specific circumstances of Crane, the economic
benefit theory did support the Commissioner's treatment of the
nonrecourse mortgage as a personal obligation. The footnote in Crane acknowledged the limitations of that theory when
applied to a different set of facts. Crane also stands for
the broader proposition, however, that a nonrecourse loan should be
treated as a true loan. We therefore hold that a taxpayer must
account for the proceeds of obligations he has received tax-free
and included in basis. Nothing in either § 1001(b) or in the
Court's prior decisions requires the Commissioner to permit a
taxpayer to treat a sale of encumbered property asymmetrically, by
including the proceeds of the nonrecourse obligation in basis but
not accounting for the proceeds upon transfer of the encumbered
property. See Page 461 U. S. 314 Estate of Levine v. Commissioner, 634 F.2d 12, 15 (CA2
1980). III Relying on the Code's § 752(c), 26 U.S.C. § 752(c), however,
respondents argue that Congress has provided for precisely this
type of asymmetrical treatment in the sale or disposition of
partnership property. Section 752 prescribes the tax treatment of
certain partnership transactions, [ Footnote 14 ] and § 752(c) provides that,

															"[f]or purposes of this section, a liability to which property
is subject shall, to the extent of the fair market value of such
property, be considered as a liability of the owner of the
property."

															Section 752(c) could be read to apply to a sale or disposition
of partnership property, and thus to limit the amount realized to
the fair market value of the property transferred. Inconsistent
with this interpretation, however, is the language of § 752(d),
which specifically mandates that partnership liabilities be treated
"in the same manner as liabilities in connection with the sale or
exchange Page 461 U. S. 315 of property not associated with partnerships." The apparent
conflict of these subsections renders the facial meaning of the
statute ambiguous, and therefore we must look to the statute's
structure and legislative history.

															Subsections (a) and (b) of § 752 prescribe rules for the
treatment of liabilities in transactions between a partner and his
partnership, and thus for determining the partner's adjusted basis
in his partnership interest. Under § 704(d), a partner's
distributive share of partnership losses is limited to the adjusted
basis of his partnership interest. 26 U.S.C. § 704(d) (1976 ed.,
Supp. V); see Perry, Limited Partnerships and Tax
Shelters: The Crane Rule Goes Public, 27 Tax L.Rev. 525,
543 (1972). When partnership liabilities are increased or when a
partner takes on the liabilities of the partnership, § 752(a)
treats the amount of the increase or the amount assumed as a
contribution by the partner to the partnership. This treatment
results in an increase in the adjusted basis of the partner's
interest and a concomitant increase in the § 704(d) limit on his
distributive share of any partnership loss. Conversely, under §
752(b), a decrease in partnership liabilities or the assumption of
a partner's liabilities by the partnership has the effect of a
distribution, thereby reducing the limit on the partner's
distributive share of the partnership's losses. When property
encumbered by liabilities is contributed to or distributed from the
partnership, § 752(c) prescribes that the liability shall be
considered to be assumed by the transferee only to the extent of
the property's fair market value. Treas.Reg. § 1.752-1(c), 26 CFR §
1.752-1(c) (1982).

															The legislative history indicates that Congress contemplated
this application of § 752(c). Mention of the fair market value
limitation occurs only in the context of transactions under
subsections (a) and (b). [ Footnote 15 ] The sole reference to subsection Page 461 U. S. 316 (d) does not discuss the limitation. [ Footnote 16 ] While the legislative history is
certainly not conclusive, it indicates that the fair market value
limitation of § 752(c) was directed to transactions between a
partner and his partnership. [ Footnote 17 ] 1 A. Willis, J. Pennell, & P.
Postlewaite, Partnership Taxation § 44.03, p. 44-3 (3d ed.1981);
Simmons, Tufts v. Commissioner: Amount Realized Limited to
Fair Market Value, 15 U.C.D.L.Rev. 577, 611-613 (1982).

															By placing a fair market value limitation on liabilities
connected with property contributions to and distributions from
partnerships under subsections (a) and (b), Congress apparently
intended § 752(c) to prevent a partner from inflating the basis of
his partnership interest. Otherwise, a partner with no additional
capital at risk in the partnership could raise the § 704(d) limit
on his distributive share of partnership losses or could reduce his
taxable gain upon disposition of his partnership Page 461 U. S. 317 interest. See Newman, The Resurgence of Footnote 37: Tufts v. Commissioner, 18 Wake Forest L.Rev. 1, 16, n. 116
(1982). There is no potential for similar abuse in the context of §
752(d) sales of partnership interests to unrelated third parties.
In light of the above, we interpret subsection (c) to apply only to
§ 752(a) and (b) transactions, and not to limit the amount realized
in a sale or exchange of a partnership interest under § 752(d). IV When a taxpayer sells or disposes of property encumbered by a
nonrecourse obligation, the Commissioner properly requires him to
include among the assets realized the outstanding amount of the
obligation. The fair market value of the property is irrelevant to
this calculation. We find this interpretation to be consistent with Crane v. Commissioner, 331 U. S. 1 (1947),
and to implement the statutory mandate in a reasonable manner. National Muffler Dealers Assn. v. United States, 440 U. S. 472 , 440 U. S. 476 (1979).

															The judgment of the Court of Appeals is therefore reversed. It is so ordered. [ Footnote 1 ]

															The loss was the difference between the adjusted basis,
$1,455,740, and the fair market value of the property, $1,400,000.
On their individual tax returns, the partners did not claim
deductions for their respective shares of this loss. In their
petitions to the Tax Court, however, the partners did claim the
loss.

															[ Footnote 2 ]

															The Commissioner determined the partnership's gain on the sale
by subtracting the adjusted basis, $1,455,740, from the liability
assumed by Bayles, $1,851,500. Of the resulting figure, $395,760,
the Commissioner treated $348,661 as capital gain, pursuant to §
741 of the Internal Revenue Code of 1954, 26 U.S.C. § 741, and
$47,099 as ordinary gain under the recapture provisions of § 1250
of the Code. The application of § 1250 in determining the character
of the gain is not at issue here.

															[ Footnote 3 ]

															Section 113(a)(5) defined the basis of "property . . . acquired
by . . . devise . . . or by the decedent's estate from the
decedent" as "the fair market value of such property at the time of
such acquisition." The Court interpreted the term "property" to
refer to the physical land and buildings owned by Crane or the
aggregate of her rights to control and dispose of them. 331 U.S. at 331 U. S. 6 .

															[ Footnote 4 ]

															Crane also argued that, even if the statute required the
inclusion of the amount of the nonrecourse debt, that amount was
not Sixteenth Amendment income because the overall transaction had
been "by all dictates of common sense . . . a ruinous disaster."
Brief for Petitioner in Crane v. Commissioner, O.T. 1946,
No. 68, p. 51. The Court noted, however, that Crane had been
entitled to and actually took depreciation deductions for nearly
seven years. To allow her to exclude sums on which those deductions
were based from the calculation of her taxable gain would permit
her "a double deduction . . . on the same loss of assets." The
Sixteenth Amendment, it was said, did not require that result. 331
U.S. at 331 U. S.
15 -16.

															[ Footnote 5 ]

															The Commissioner might have adopted the theory, implicit in
Crane's contentions, that a nonrecourse mortgage is not true debt,
but, instead, is a form of joint investment by the mortgagor and
the mortgagee. On this approach, nonrecourse debt would be
considered a contingent liability, under which the mortgagor's
payments on the debt gradually increase his interest in the
property while decreasing that of the mortgagee. Note, Federal
Income Tax Treatment of Nonrecourse Debt, 82 Colum.L.Rev. 1498,
1514 (1982); Lurie, Mortgagor's Gain on Mortgaging Property for
More than Cost Without Personal Liability, 6 Tax L.Rev. 319, 323
(1951); cf. Brief for Respondents 16 (nonrecourse debt
resembles preferred stock). Because the taxpayer's investment in
the property would not include the nonrecourse debt, the taxpayer
would not be permitted to include that debt in basis. Note, 82
Colum.L.Rev. at 1515; cf. Gibson Products Co. v. United
States, 637 F.2d 1041, 1047-1048 (CA5 1981) (contingent nature
of obligation prevents inclusion in basis of oil and gas leases of
nonrecourse debt secured by leases, drilling equipment, and
percentage of future production).

															We express no view as to whether such an approach would be
consistent with the statutory structure and, if so, and Crane were not on the books, whether that approach would
be preferred over Crane's analysis. We note only that the Crane Court's resolution of the basis issue presumed that,
when property is purchased with proceeds from a nonrecourse
mortgage, the purchaser becomes the sole owner of the property. 331
U.S. at 331 U. S. 6 . Under
the Crane approach, the mortgagee is entitled to no
portion of the basis. Id. at 331 U. S. 10 , n.
28. The nonrecourse mortgage is part of the mortgagor's investment
in the property, and does not constitute a coinvestment by the
mortgagee. But see Note, 82 Colum.L.Rev. at 1513 (treating
nonrecourse mortgage as coinvestment by mortgagee and critically
concluding that Crane departed from traditional analysis
that basis is taxpayer's investment in property).

															[ Footnote 6 ]

															In this case, respondents received the face value of their note
as loan proceeds. If respondents initially had given their note at
a discount, the amount realized on the sale of the securing
property might be limited to the funds actually received. See
Commissioner v. Rail Joint Co., 61 F.2d 751, 752 (CA2 1932)
(cancellation of indebtedness); Fashion Park, Inc. v.
Commissioner, 21 T.C. 600, 606 (1954) (same). See
generally J. Sneed, The Configurations of Gross Income 319
(1967) ("[I]t appears settled that the reacquisition of bonds at a
discount by the obligor results in gain only to the extent the
issue price, where this is less than par, exceeds the cost of
reacquisition").

															[ Footnote 7 ]

															The Commissioner's choice in Crane "laid the foundation
stone of most tax shelters," Bittker, Tax Shelters, Nonrecourse
Debt, and the Crane Case, 33 Tax L.Rev. 277, 283 (1978),
by permitting taxpayers who bear no risk to take deductions on
depreciable property. Congress recently has acted to curb this
avoidance device by forbidding a taxpayer to take depreciation
deductions in excess of amounts he has at risk in the investment.
Pub.L. 94-455, § 204(a), 90 Stat. 1531 (1976), 26 U.S.C. § 465;
Pub.L. 95-600, §§ 201-204, 92 Stat. 2814-2817 (1978), 26 U.S.C. §
465(a) (1976 ed., Supp. V). Real estate investments, however, are
exempt from this prohibition. § 465(c)(3)(D) (1976 ed., Supp. V).
Although this congressional action may foreshadow a day when
nonrecourse and recourse debts will be treated differently, neither
Congress nor the Commissioner has sought to alter Crane's rule of including nonrecourse liability in both basis and the
amount realized.

															[ Footnote 8 ]

															Although the Crane rule has some affinity with the tax
benefit rule, see Bittker, supra, at 282; Del Cotto, Sales
and Other Dispositions of Property Under Section 1001: The Taxable
Event, Amount Realized and Related Problems of Basis, 26 Buffalo
L.Rev. 219, 323-324 (1977), the analysis we adopt is different. Our
analysis applies even in the situation in which no deductions are
taken. It focuses on the obligation to repay and its subsequent
extinguishment, not on the taking and recovery of deductions. See generally Note, 82 Colum.L.Rev. at 1526-1529.

															[ Footnote 9 ]

															The regulation was promulgated while this case was pending
before the Court of Appeals for the Fifth Circuit. T.D. 7741, 45
Fed.Reg. 81743, 1981-1 Cum.Bull. 430 (1980). It merely formalized
the Commissioner's prior interpretation, however.

															[ Footnote 10 ]

															The Court of Appeals for the Third Circuit, in Millar, affirmed the Tax Court on the theory that inclusion of nonrecourse
liability in the amount realized was necessary to prevent the
taxpayer from enjoying a double deduction. 577 F.2d at 215; cf. n 4, supra. Because we resolve the question on another ground,
we do not address the validity of the double deduction
rationale.

															[ Footnote 11 ]

															Professor Wayne G. Barnett, as amicus in the present
case, argues that the liability and property portions of the
transaction should be accounted for separately. Under his view,
there was a transfer of the property for $1.4 million, and there
was a cancellation of the $1.85 million obligation for a payment of
$1.4 million. The former resulted in a capital loss of $50,000, and
the latter in the realization of $450,000 of ordinary income.
Taxation of the ordinary income might be deferred under § 108 by a
reduction of respondents' bases in their partnership interests.

															Although this indeed could be a justifiable mode of analysis, it
has not been adopted by the Commissioner. Nor is there anything to
indicate that the Code requires the Commissioner to adopt it. We
note that Professor Barnett's approach does assume that recourse
and nonrecourse debt may be treated identically.

															The Commissioner also has chosen not to characterize the
transaction as cancellation of indebtedness. We are not presented
with, and do not decide, the contours of the
cancellation-of-indebtedness doctrine. We note only that our
approach does not fall within certain prior interpretations of that
doctrine. In one view, the doctrine rests on the same initial
premise as our analysis here -- an obligation to repay -- but the
doctrine relies on a freeing-of-assets theory to attribute ordinary
income to the debtor upon cancellation. See Commissioner v.
Jacobson, 336 U. S. 28 , 336 U. S. 38 -40
(1949); United States v. Kirby Lumber Co., 284 U. S.
1 , 284 U. S. 3 (1931). According to that view, when nonrecourse debt is forgiven,
the debtor's basis in the securing property is reduced by the
amount of debt canceled, and realization of income is deferred
until the sale of the property. See Fulton Gold Corp. v.
Commissioner, 31 B.T.A. 519, 520 (1934). Because that
interpretation attributes income only when assets are freed,
however, an insolvent debtor realizes income just to the extent his
assets exceed his liabilities after the cancellation. Lakeland
Grocery Co. v. Commissioner, 36 B.T.A. 289, 292 (1937).
Similarly, if the nonrecourse indebtedness exceeds the value of the
securing property, the taxpayer never realizes the full amount of
the obligation canceled, because the tax law has not recognized
negative basis.

															Although the economic benefit prong of Crane also
relies on a freeing-of-assets theory, that theory is irrelevant to
our broader approach. In the context of a sale or disposition of
property under § 1001, the extinguishment of the obligation to
repay is not ordinary income; instead, the amount of the canceled
debt is included in the amount realized, and enters into the
computation of gain or loss on the disposition of property.
According to Crane, this treatment is no different when
the obligation is nonrecourse: the basis is not reduced as in the
cancellation-of-indebtedness context, and the full value of the
outstanding liability is included in the amount realized. Thus, the
problem of negative basis is avoided.

															[ Footnote 12 ]

															In his opinion for the Court of Appeals in Crane, Judge
Learned Hand observed:

															"[The mortgagor] has all the income from the property; he
manages it; he may sell it; any increase in its value goes to him;
any decrease falls on him, until the value goes below the amount of
the lien. . . . When, therefore, upon a sale, the mortgagor makes
an allowance to the vendee of the amount of the lien, he secures a
release from a charge upon his property quite as though the vendee
had paid him the full price on condition that, before he took
title, the lien should be cleared. . . ."

															153 F.2d 504, 506 (CA2 1945).

															[ Footnote 13 ]

															In the present case, the Government bore the ultimate loss. The
nonrecourse mortgage was extended to respondents only after the
planned complex was endorsed for mortgage insurance under §§ 221(b)
and (d)(4) of the National Housing Act, 12 U.S.C. §§ 17151(b) and
(d)(4) (1976 ed. and Supp. V). After acquiring the complex from
respondents, Bayles operated it for a few years, but was unable to
make it profitable. In 1974, F&H foreclosed, and the Department
of Housing and Urban Development paid off the lender to obtain
title. In 1976, the Department sold the complex to another
developer for $1,502,000. The sale was financed by the Department's
taking back a note for $1,314,800 and a nonrecourse mortgage. To
fail to recognize the value of the nonrecourse loan in the amount
realized, therefore, would permit respondents to compound the
Government's loss by claiming the tax benefits of that loss for
themselves.

															[ Footnote 14 ]

															Section 752 provides:

															"(a) Increase in partner's liabilities"

															"Any increase in a partner's share of the liabilities of a
partnership, or any increase in a partner's individual liabilities
by reason of the assumption by such partner of partnership
liabilities, shall be considered as a contribution of money by such
partner to the partnership."

															"(b) Decrease in partner's liabilities"

															"Any decrease in a partner's share of the liabilities of a
partnership, or any decrease in a partner's individual liabilities
by reason of the assumption by the partnership of such individual
liabilities, shall be considered as a distribution of money to the
partner by the partnership."

															"(c) Liability to which property is subject"

															"For purposes of this section, a liability to which property is
subject shall, to the extent of the fair market value of such
property, be considered as a liability of the owner of the
property."

															"(d) Sale or exchange of an interest"

															"In the case of a sale or exchange of an interest in a
partnership, liabilities shall be treated in the same manner as
liabilities in connection with the sale or exchange of property not
associated with partnerships."

															[ Footnote 15 ]

															"The transfer of property subject to a liability by a partner to
a partnership, or by the partnership to a partner, shall, to the
extent of the fair market value of such property, be considered a
transfer of the amount of the liability along with the
property."

															H.R.Rep. No. 1337, 83d Cong., 2d Sess., A236 (1954); S.Rep. No.
1622, 83d Cong., 2d Sess., 405 (1954).

															[ Footnote 16 ]

															"When a partnership interest is sold or exchanged, the general
rule for the treatment of the sale or exchange of property subject
to liabilities will be applied."

															H.R.Rep. No. 1337, at A236-A237; S.Rep. No. 1622 at 405. These
Reports then set out an example of subsection (d)'s application,
which does not indicate whether the debt is recourse or
nonrecourse.

															[ Footnote 17 ]

															The Treasury Regulations support this view. The Regulations
interpreting § 752(c) state:

															"Where property subject to a liability is contributed by a
partner to a partnership, or distributed by a partnership to a
partner, the amount of the liability, to an extent not exceeding
the fair market value of the property at the time of the
contribution or distribution, shall be considered as a liability
assumed by the transferee."

															§ 1.752-1(c), 26 CFR § 1.752-1(c) (1982). The Regulations also
contain an example applying the fair market limitation to a
contribution of encumbered property by a partner to a partnership. Ibid. The Regulations interpreting § 752(d) make no
mention of the fair market limitation. § 752-1(d). Both Regulations
were issued contemporaneously with the passage of the statute, T.
D. 6175, 1956-1 Cum.Bull. 211, and are entitled to deference as an
administrative interpretation of the statute. See Commissioner
v. South Texas Lumber Co., 333 U. S. 496 , 333 U. S. 501 (1948).

															JUSTICE O'CONNOR, concurring.

															I concur in the opinion of the Court, accepting the view of the
Commissioner. I do not, however, endorse the Commissioner's view.
Indeed, were we writing on a slate clean except for the decision in Crane v. Commissioner, 331 U. S. 1 (1947),
I would take quite a different approach -- that urged upon us by
Professor Barnett as amicus. Crane established that a taxpayer could treat property
as entirely his own, in spite of the "coinvestment" provided by his
mortgagee in the form of a nonrecourse loan. That is, the full
basis of the property, with all its tax consequences, belongs to
the mortgagor. That rule alone, though, does not in any way tie
nonrecourse debt to the cost of property or to the proceeds upon
disposition. I see no reason to treat the Page 461 U. S. 318 purchase, ownership, and eventual disposition of property
differently because the taxpayer also takes out a mortgage, an
independent transaction. In this case, the taxpayer purchased
property, using nonrecourse financing, and sold it after it
declined in value to a buyer who assumed the mortgage. There is no
economic difference between the events in this case and a case in
which the taxpayer buys property with cash; later obtains a
nonrecourse loan by pledging the property as security; still later,
using cash on hand, buys off the mortgage for the market value of
the devalued property; and finally sells the property to a third
party for its market value.

															The logical way to treat both this case and the hypothesized
case is to separate the two aspects of these events and to
consider, first, the ownership and sale of the property, and,
second, the arrangement and retirement of the loan. Under Crane, the fair market value of the property on the date
of acquisition -- the purchase price -- represents the taxpayer's
basis in the property, and the fair market value on the date of
disposition represents the proceeds on sale. The benefit received
by the taxpayer in return for the property is the cancellation of a
mortgage that is worth no more than the fair market value of the
property, for that is all the mortgagee can expect to collect on
the mortgage. His gain or loss on the disposition of the property
equals the difference between the proceeds and the cost of
acquisition. Thus, the taxation of the transaction in property
reflects the economic fate of the property. If the property has
declined in value, as was the case here, the taxpayer recognizes a
loss on the disposition of the property. The new purchaser then
takes as his basis the fair market value as of the date of the
sale. See, e.g., United States v. Davis, 370 U. S.
65 , 370 U. S. 72 (1962); Gibson Products Co. v. United States, 637 F.2d
1041, 1046, n. 8 (CA5 1981) (dictum); see generally Treas.Reg. § 1.10012(a)(3), 26 CFR § 1.1001-2(a)(3) (1982); 2 B.
Bittker, Federal Taxation of Income, Estates and Gifts 41.2.2., pp.
41-10 - 41-11 (1981). Page 461 U. S. 319 In the separate borrowing transaction, the taxpayer acquires
cash from the mortgagee. He need not recognize income at that time,
of course, because he also incurs an obligation to repay the money.
Later, though, when he is able to satisfy the debt by surrendering
property that is worth less than the face amount of the debt, we
have a classic situation of cancellation of indebtedness, requiring
the taxpayer to recognize income in the amount of the difference
between the proceeds of the loan and the amount for which he is
able to satisfy his creditor. 26 U.S.C. § 61(a)(12). The taxation
of the financing transaction then reflects the economic fate of the
loan.

															The reason that separation of the two aspects of the events in
this case is important is, of course, that the Code treats
different sorts of income differently. A gain on the sale of the
property may qualify for capital gains treatment, §§ 1202, 1221
(1976 ed. and Supp. V), while the cancellation of indebtedness is
ordinary income, but income that the taxpayer may be able to defer.
§§ 108, 1017 (1976 ed., Supp. V). Not only does Professor Barnett's
theory permit us to accord appropriate treatment to each of the two
types of income or loss present in these sorts of transactions, it
also restores continuity to the system by making the
taxpayer-seller's proceeds on the disposition of property equal to
the purchaser's basis in the property. Further, and most important,
it allows us to tax the events in this case in the same way that we
tax the economically identical hypothesized transaction.

															Persuaded though I am by the logical coherence and internal
consistency of this approach, I agree with the Court's decision not
to adopt it judicially. We do not write on a slate marked only by Crane. The Commissioner's longstanding position, Rev.Rul.
76-111, 1976-1 Cum.Bull. 214, is now reflected in the regulations.
Treas.Reg. § 1.1001-2, 26 CFR § 1.1001-2 (1982). In the light of
the numerous cases in the lower courts including the amount of the
unrepaid proceeds of the mortgage in the proceeds on sale or
disposition, see, Page 461 U. S. 320 e.g., Estate of Levine v. Commissioner, 634 F.2d 12, 15
(CA2 1980); Millar v. Commissioner, 577 F.2d 212 (CA3), cert. denied, 439 U.S. 1046 (1978); Estate of Delman
v. Commissioner, 73 T.C. 15, 28-30 (1979); Peninsula
Properties Co., Ltd. v. Commissioner, 47 B.T.A. 84, 92 (1942),
it is difficult to conclude that the Commissioner's interpretation
of the statute exceeds the bounds of his discretion. As the Court's
opinion demonstrates, his interpretation is defensible. One can
reasonably read § 1001(b)'s reference to "the amount realized from the sale or other disposition of property" (emphasis
added) to permit the Commissioner to collapse the two aspects of
the transaction. As long as his view is a reasonable reading of §
1001(b), we should defer to the regulations promulgated by the
agency charged with interpretation of the statute. National
Muffler Dealers Assn. v. United States, 440 U.
S. 472 , 440 U. S.
488 -489 (1979); United States v. Correll, 389 U. S. 299 , 389 U. S. 307 (1967); see also Fulman v. United States, 434 U.
S. 528 , 434 U. S. 534 (1978). Accordingly, I concur.

Summary:
Here is a summary of the Supreme Court case Commissioner v. Tufts (1983):

Issue: Whether a taxpayer who sells property encumbered by a nonrecourse loan, where the loan exceeds the property's fair market value, must include the outstanding loan amount in the "amount realized" for tax purposes.

Holding: The Court held that the taxpayer must include the full amount of the nonrecourse loan in the "amount realized" when calculating gain or loss on the sale or disposition of the property. The fair market value of the property is irrelevant to this calculation.

Reasoning: When a mortgagor's loan is canceled, they are relieved of their repayment obligation and thus realize value within the meaning of the Internal Revenue Code (IRC) § 1001(b). Including the full loan amount in the "amount realized" prevents taxpayers from claiming tax losses without corresponding economic losses. The Court interpreted the IRC's reference to "amount realized from the sale or other disposition of property" as allowing the Commissioner to consider the loan amount in the calculation.