T.C. Mem o. 2 01 4- 22 6

UNITED STAT ES TAX COURT

CHARLES COPELAND AND A RLENE COPELAND, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 56 05 -1 3. Fi le d Oct ob er 3 0, 2 01 4.

Ch arl es Co pe la ndan d Arl en e Co pe la nd , pro se. Seb as ti anVoth, fo r res po nd en t.

MEMORANDUM OPINION LAUBER, Ju dg e: The In te rn al Rev enue Serv ic e (IR S o r res po nd en t) de te rm in eda de fic ie nc y

inpe ti ti on ers ’ Fed eral in co m e ta x fo r 20 10 . After co nc es si on s, th e so le rem ai ni ng is su e is whet he r pe ti ti on ers are en ti tl edto a

1
Pet it io ne rs co nc ed edth atun em pl oym en t co m

pe ns at io n o f $3 ,13 3 re cei ve d 1 (co nt in ue d...)- 2 -

[* 2] m ortg ag e in te res t d educ ti onun de r se ct io n 1 63 (a) a nd(h) (2 )(d ) forin te res t 2 th atwas c ap it al iz edin to th e p rin ci pa l o f th ei r m ortg ag e n ot e b utno t ac tu al ly pai d du rin g 2 01 0. We ho ldth atth ey are n otso en ti tl ed . Bac kg ro un d Thi s ca se was s ub m it te d fu ll y st ip ul at edun de r Ru le 12 2. Th e st ip ul at ed fact s an d t he rel at edex hi bi ts are i nc or po rat edby thi s re fere nc e. Pet it io ne rs res id edinCal ifo rn iawhen th ey pe ti ti on edth is Co urt. Pet it io ne rs are ca shba si s t ax pa y ers . In 1 99 1 t he y pu rch as eda res id en ti al pr op erty inYuca ip a, Cal ifo rn ia , for$3 34 ,00 0. Th ey fin an cedth is pu rch as e wit h a $3 00 ,00 0 m ortg ag e lo ansec ur edby the pro pe rty. Peti ti on ers ha ve oc cupi edth is pr op erty as t he ir h om e si nc e 1 99 1. In 20 07 pe ti ti on ers refi na nc edth e Yuc ai pa pr op erty with a$6 00 ,00 0 l oa n fr om Gate way Fund in g Di ve rs ifi edMo rtg ag e Serv ic es (GFDMS) . This lo anwas l ik ewis e se cu redby a m ortg ag e o n t he pr op erty . Ban k o f Am eri ca s ub se qu en tl y acqui redth e GFDMS m ortg ag e lo an . (...co nt inue d) 1 in 20 10 was i nc lu di bl e in tax ab le in co m e. Res po nd en t co nc ed edth ata he al th sa vi ng s ac co un t d is tri bu ti on of $ 2,4 00 rece iv edin20 10 was n otin cl ud ib le in ta xabl e in co m e. All st atut ory

refe ren ces are t o t he Int ern al Rev enue Co de as i n e ffec t fo r th e 2 ta xabl e y ear i n i ss ue . All R ul e ref eren ces are t o t he Tax C ou rt R ul es of P ract ic e an d P ro cedur e. W e ro un d a ll m on et ary am ou nt s t o the ne ares t d ol lar.- 3 -

[* 3] In20 10 pe ti ti on ers ap pl ie d fo r a l oa n m od ifi cat io n wi th Ban k o f Am eri ca. Thi s ap pl ic at io n was gra nt ed , andth e te rm s o f pe ti ti on ers ’ m ortg ag e lo anwere pe rm an en tl y

m od ifi ed . The m od ifi cat io ns in cl ud eda reduc ti onof t he in te res t ra te , a ch an ge inth e p aym en t t erm s, an d a n i nc reas e in th e lo anba la nc e. Im m ed ia te ly be fo re the m od ifi cat io ns , th e o ut st an di ng lo anba la nc e was $5 79 ,27 5; aft er the m od ifi cat io ns , th e n ew ba la nc e was $6 23 ,95 3. Th e d iff eren ce (e qu al to $4 4,6 78 ) res ul te d fr om

ad di ng th e fo ll owi ng am ou nt s t o t he lo anba lanc e: pas t due in te res t of $3 0,2 73 , servi ci ng ex pe ns e o f $1 80 , andch arg es for tax es an d i ns ur an ce o f $1 4,2 25 . Ban k o f Am eri ca i ss ue d p et it io ne rs Fo rm 10 98 , Mo rtg ag e In te res t St at em en t, re po rti ng th atitha d re cei ve d fr om th em durin g 2 01 0 i nt eres t o f $9 ,25 3 wi th res pe ctto th e Yuc ai papro pe rty. O n t he ir t im el y fil ed20 10 tax return, p et it io ne rs cl ai m eda de du ct io n o f $4 8,0 78 forho m e m ortg ag e in te res t. The IRS i ss ue d p et iti on ers a no ti ce o f de fic ie nc y di sa ll owi ng $3 8,8 25 of thi s d educ ti on , nam el y , th e am ou ntby whi ch itex ceed edth e in te res t tha t Ba nkof Am eri ca h adrep orte d o n Fo rm 10 98 . Peti ti on ers ha ve co nc ed edth at$8 ,55 2 o f th is de du ct io n was pro pe rly di sa ll owe d. Th ey

co nt en d, h owe ve r, th atth ey are en ti tl edto th e rem ai nd er o f th e cl ai m edde du ct io n, o r $3 0,2 73 . This rep res en ts th e p as t-due in te res t tha t p et it io n-- 4 -

[* 4] ers di d n otpa y

du rin g 2 01 0 wh ic h was cap it al iz edin to th e p rin ci pa l o f th ei r m od ifi edm ortg ag e lo an . Dis cu ss io n Deduc ti on s ar e a m at te r of leg is la ti ve gra ce, an d t he bu rd enis on th e ta xpa y er t o p ro ve en ti tl em en t t o t he de du ct io ns cla im ed . INDOPCO, Inc . v. Co m m is si on er, 5 03 U.S. 79 , 84 (19 92 ); Ne w Col on ia l Ic e Co . v. Hel ve rin g, 2 92 U.S. 43 5, 44 0 (1 93 4) . This cas e was subm it te d fu ll y st ip ul at edun de r Ru le 12 2. Si nc e th ere rem ai n o nl y

leg al is su es , th e b ur de n o f pr oo f is irr el ev an t. See , e.g., Nis Fam il y Trus t v . Comm is si on er, 1 15 T.C. 52 3, 5 38 (20 00 ). Sect io n 1 63 (a) g en eral ly allo ws a d educ ti on forin te res t. Ho wev er, s ect io n 16 3( h) (1 ) pr ov id es th at“ [i]n t he cas e o f a t ax pa y er o th er tha n aco rp or at io n, n o de du ct io n s ha ll be all owe d * * * forpe rs on al in te res t p ai d o r acc ru eddu rin g t he ta xabl e y ear.” Non de du ct ib le “pe rs on al in te res t” is de fin edto ex cl ud e se ve ral cat eg or ie s o f in te res t, i nc lu di ng “ an y qu al ifi edres id en ce i nt eres t.” Se c. 16 3( h) (2 )(D), (3 ). The p art ie s ag ree t ha t dur in g 2 01 0 t he Yuca ip a p ro pe rty was a

“ qu al ifi edres id en ce” a ndth atpe ti ti on ers pa idso m e “ qu al ifi edres id en ce i nt eres t.” The y di sa gr ee as to whethe r th e am ou ntde du ct ib le as “ qu al ifi edres id en ce i nt eres t” in cl ud es th e $ 30 ,27 3 t ha t was cap it al iz edin to th e p rin ci pa l o f th e Ban k o f Am eri ca l oa n.- 5 -

[* 5] Pet it io ne rs are ca shba si s t ax pa y ers . It i s wel l s et tl edth at“ [a] cash -b as is ta xp ay er ‘pays’ in te res t o nl y when he pa y s ca sh or i ts equi va le ntto hi s l en de r.” W il ke rs on v. Co m

m is si on er, 6 55 F.2d98 0, 9 82 (9t h C ir. 1 98 1) , rev ’g 70 T.C. 24 0 (1 97 8) ; Dav is on v. Co m

m is si on er, 1 07 T.C. 35 , 41 (19 96 ), aff’d, 1 41 F.3d40 3 (2 d Ci r. 19 98 ); S m ok er v . Comm is si on er, T.C. Mem o. 2 01 3- 56 . The d el iv ery of a pr om is so ry

no te to sat is fy

anin te res t o bl ig at io n, wi th ou t an acco m pa nyin g d is ch arg e o f th e n ot e, is a m ere p ro m is e to pa y , no t a p aym en t i n c as h o r it s equi va le nt . DonE. W il li am s C o. v . Comm is si on er, 4 29 U.S. 56 9, 5 77 -5 78 (19 77 ); W il ke rs on , 65 5 F .2dat 9 82 ; Dav is on , 10 7 T.C. at41 ; s ee Un it edSta te s v . Cla rdy , 61 2 F .2d11 39 , 11 51 (9t h C ir. 1 98 0) (“ It i s u nd is pu te d t ha t i f a n ew no te is gi ve n to sat is fy anin te res t o bl ig at io n b y a de bt oron a cas h b as is , th e in te res t h as no t be en‘ pa id .’ ”). The rat io na le forth is rul e is th at“ th e n ot e m ay ne ve r be pa id , and if i t i s n otpa id , ‘ th e ta xp ay er h as pa rte d wi th no th in g m or e th anhi s p ro m is e to pa y .’ ” Don E. W il li am s C o., 4 29 U.S. at 5 78 (qu ot in g Hart v . Comm is si on er, 5 4 F.2 d 8 48 , 85 2 (1 stCir . 19 32 ), aff’g i n p art , rev ’g inpa rt 2 1 B .T.A. 100 1 (1 93 0) ). The same rul e ap pl ie s t o adi sc ou nt edlo an . Whe re a l en de r wit hh ol ds a su m as in te res t fr om

th e fac e am ou ntof alo an , th e b orro wer i s n otreg ard edas h av in g

“pa id ” th atin te res t. See Davi so n, 1 07 T.C. at 4 1; Men z v . Comm is si on er, 8 0 T.C. 11 74 , 11 86 (19 83 ). Whe th er i nt eres t i s s ub tra ct edfro m th e lo anpro ceed s o r- 6 -

[* 6] ad de d t o t he lo anpri nc ip al , th e eco no m ic real it y is th e sa m e. Ineach cas e, th e b orro wer i s ab le to po stpo ne pa y in g t he in te res t u nt il so m e ti m e inth e fu tu re, ov er the li fe o f th e lo anor a s p artof aba ll oo n p aym en t atm atur ity . See Heym an v. Co m m is si on er, 7 0 T.C. 4 82 , 48 5- 48 7 (1 97 8) , aff’d, 6 52 F.2d59 8 (6 thCir . 19 80 ); Rub ni tz v. Co m

m is si on er, 6 7 T.C. 6 21 , 62 7- 62 8 (1 97 7) ; Sm ok er, T.C. Mem o. 2 01 3- 56 . Thro ug h t he lo anm od ifi cat io n a gr eem en t, the $3 0,2 73 inpa st -due in te res t on pe ti ti on ers ’ m ortg ag e lo anwas a dd edto th e p rin ci pa l. No m on ey ch an ge d ha nd s; pe ti ti on ers si m

pl y pro m is edto pa y

th e p as t-due in te res t, al on g wi th th e res t of th e p rin ci pa l, ata la te r da te . Becau se pe ti ti on ers di d n otpa y th is in te res t dur in g 20 10 incas h o r it s equi va le nt , th ey can no t cl ai m

a de du ct io n fo r itfor20 10 . They wil l b e en ti tl edto a de du ct io n i f an d wh enth ey actua ll y di sc ha rg e th is po rti on of th ei r lo anob li ga ti on ina fu tu re y ear. Se e Sm ok er, at*1 1- *1 2. Aga in stth is ba ck dr op of s et tl edcas el aw, pe ti ti on ers askus to rech arac te riz e th ei r lo anm od ifi cat io n t ran sa ct io n. In st eadof h av in g m od ifi edth e te rm s o f th ei r ex is ti ng lo an , pet it io ne rs say the y sh ou ldbe tre at edas i f th ey ha d o bt ai ne d ane w lo anfro m a di ffer en t l en de r an d u se d the pro ceed s o f th atlo anto pa y bo th th e pr in ci pa l o f th e Ban k o f Am eri ca l oa n a ndth e p as t-due in te res t. Cf. Wilk ers on , 65 5 F .2dat 9 84 (st at in g t ha t i f a s ep arat e lo anfro m a th irdparty is u se d t o p ay- 7 -

[* 7] in te res t, “ a d educ ti on m ay be ap pr op ria te be cau se th e o bl ig at io n b etweenth e bo rro wer an d t he ori gi na l l en de r ha s n otm erel y be enpo stpo ne d, i t h as be en ex ti ng ui sh ed ”). Co nt rary to p et it io ne rs ’ “ subs ta nc e o ve r fo rm ” arg um en t, the tra ns act io n th ey hypo th es iz e is no t ec on om ic al ly equ iv al en t t o t he trans act io n i n wh ic h t he y en ga ge d. Fo r on e th in g, p et it io ne rs ha ve supp li edno reas on to be li ev e th atth ey co ul d h av e o bt ai ne d a$6 23 ,95 2 l oa n fr om a di ffer en t l en de r, gi ve n t he eco no m ic en vi ro nm en t p rev ai li ng in20 10 . In an y ev en t, i t i s wel l es tabl is he d t ha t t ax pa y ers m us t ac cep t the tax co ns eque nc es of t he tra ns act io n i n wh ic h t he y actua ll y en ga ge d, ev enif a lt ern at iv e arr an ge m en ts m ig htha ve pro vi de d m or e d es irabl e ta x res ul ts . See Do n E. Will ia m s C o., 4 29 U.S. at 5 79 -5 81 ; No bl e v . Comm is si on er, 79 T.C. 75 1, 7 67 (19 82 ); S m ok er, at*1 2. 3 Insu m , a tax pa y er i s n ot“ en ti tl edto m ortg ag e in te res t d educ ti on s fo r am ou nt s capi ta li zedin to th e p rin ci pa l o f a m ortg ag e n ot e b utno t ac tu al ly pai d.”
Alt ern at iv el y , pet it io ne rs say the y sh ou ldbe tre at edas i f th ey ha d o bt ai ne d 3 a n ew lo anfro m

Ban k o f Am eri ca an d u se d t he ne w lo anpro ceed s t o d is ch arg e th e ol d l oa n a ndth e p as t-due in te res t. Bu t p et it io ne rs wou ldno t b e tr eat edas h av in g “pa id ” th e in te res t i n t hi s ev en t ei th er. Rat he r, th ey wou ldbe reg ard edas h av in g po stpo ne d p aym en t o f th atin te res t b y gi vi ng Ban k o f Am eri ca a n ot e, as th ey di d th ro ug h t he lo anm od ifi cat io n a rran ge m en t i n wh ic h t he y actua ll y en ga ge d. Wilke rs on , 65 5 F .2dat 9 84 ; Ba tt el st ei n v . Comm is si on er, 6 31 F.2d11 82 , 11 84 & n .3 (5 th Cir . 19 80 ); Da vi so n, 1 07 T.C. at 4 1- 51 .- 8 -

[* 8] Sm ok er, at*2 . W e acc or di ng ly con cl ud e th atpe ti ti on ers can no t d educ t fo r 20 10 th e $ 30 ,27 3 o f pa st -due in te res t tha t was no t p ai d fo r 20 10 bu t p os tp on edby be in g a dd edto th e lo anba la nc e. To re fle ctth e fo reg oi ng , Deci si on wil l b e en te redun de r Ru le 15 5.