1All section references are to the Internal Revenue Code in

effect for 1994, all Rule references are to the Tax Court Rules

(continued...)

T.C. Memo. 1999-162

UNITED STATES TAX COURT

JERRY MYERS JOHNSON, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14639-97. Filed May 13, 1999.

Jerry Myers Johnson, pro se.

Wendy L. Wojewodzki, for respondent.

MEMORANDUM OPINION

FAY, Judge: Respondent determined a deficiency in

petitioner's 1994 Federal income tax of $32,794 and an accuracyrelated penalty under section 66621 in the amount of $6,559. 
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1(...continued)

of Practice and Procedure, and all dollar amounts have been

rounded to the nearest dollar.

After concessions, the sole issue for decision is whether

petitioner must recognize discharge of indebtedness income

pursuant to section 61(a)(12). Petitioner bears the burden of

disproving respondent's determination on this issue. See Rule

142(a).

 Some of the facts have been stipulated and are so found. 

The stipulation of facts and the accompanying exhibits are

incorporated herein by this reference. Petitioner resided in

Shepherdstown, West Virginia, when he filed his petition. During

the year in issue, petitioner timely filed a separate Federal

income tax return.

The facts are undisputed. In 1990, petitioner and his

former wife, Norene, borrowed $130,612 from PNC Mortgage Corporation of America (PNC) to finance their purchase of a home in

Somerset, New Jersey. The Department of Veterans' Affairs

guaranteed the loan. In 1994, PNC foreclosed on the property

after petitioner and Norene (hereinafter sometimes referred to as

the borrowers) had defaulted on their payment obligations. The

property was sold for $93,251 by the county sheriff in July 1994. 

At the time of the foreclosure, the borrowers owed PNC $160,014,

consisting of $129,292 mortgage principal, $23,489 accrued and
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unpaid interest, $3,672 in escrow fees, and $3,561 in liquidation

expenses. The parties have stipulated that, in March 1994, 4

months before the foreclosure sale, the property had a fair

market value of $105,000, and that, after the sale, PNC discharged the balance due in the amount of $66,763. Petitioner was

not insolvent when the discharge occurred.

PNC issued petitioner a Form 1099-C (Cancellation of Debt),

reflecting that he had received $66,763 in discharge of indebtedness income during 1994. Petitioner did not report any of this

amount on his 1994 Federal income tax return. In the notice of

deficiency, respondent increased petitioner's income by $66,763. 

Respondent now concedes that petitioner need report only the

amount by which the outstanding balance of the loan exceeds the

fair market value of the property. Respondent concedes further

that, under section 108(e)(2), petitioner is entitled to exclude

the accrued interest of $23,489 from the discharged indebtedness,

because payment of that liability would have given rise to a

deduction. Thus, according to respondent, the difference of

$55,014 (outstanding loan balance of $160,014, less the property's fair market value of $105,000, as stipulated) represents

petitioner's discharge of indebtedness, of which only $31,525 is

taxable because of the accrued interest exclusion.

Petitioner admits to realizing discharge of indebtedness

income. He argues, however, that the full amount should be
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excluded from his gross income because the discharge occurred

when he was forced into early retirement by "city and state

government representatives [who] illegally and unjustly interfered in * * * [his] career as a teacher".

Where a recourse mortgage has been discharged, cancellation

of indebtedness income arises to the extent the amount of the

debt exceeds the fair market value of the property. See Gehl v.

Commissioner, 102 T.C. 784, 786 (1994), affd. without published

opinion 50 F.3d 12 (8th Cir. 1995); Bialock v. Commissioner, 35

T.C. 649, 660 (1961); sec. 1.1001-2(c), Example (8), Income Tax

Regs. Based on all the surrounding facts and circumstances, a

debt is considered discharged the moment it becomes clear that it

will never be repaid. See Cozzi v. Commissioner, 88 T.C. 435,

445 (1987).

Respondent argues that, in 1994, when petitioner was discharged from having to pay the balance due on foreclosure, he

realized cancellation of indebtedness income. Petitioner makes

no argument to the contrary. For example, he presents no

evidence suggesting that the unpaid recourse liability survives

as a legally enforceable obligation against him or, alternatively, that he had no obligation to repay the loan initially

advanced by PNC. Moreover, petitioner does not dispute that, if

the indebtedness is found to be taxable, the amount includable is

$31,525, the difference between the outstanding loan and the
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property's fair market value, or $55,014, less the forgiven

interest of $23,489.

Generally, a taxpayer must include in gross income a discharge of indebtedness. See sec. 61(a)(12); sec. 1.61-12(a),

Income Tax Regs. The rationale for this principle is that, when

a debt is forgiven, formerly encumbered assets of the borrower

become freely available for his use and enjoyment. Since the

loan does not have to be repaid, the newly freed assets constitute income.

There are, however, exceptions to this general rule. 

Section 108(a) provides that a taxpayer may exclude from gross

income the discharge of indebtedness if the discharge occurs in a

bankruptcy case, or, alternatively, when the taxpayer is insolvent, or if the indebtedness is qualified farm or business real

estate debt. Petitioner concedes that he was not insolvent

within the meaning of section 108. Moreover, nothing in the

record suggests that the other circumstances described above

exist here. Similarly, there is no indication that PNC intended

to make a gift to petitioner. See Commissioner v. Jacobson, 336

U.S. 28, 51 (1949) (a gratuitous forgiveness of debt is a gift,

resulting in no income to the debtor); Helvering v. American

Dental Co., 318 U.S. 322 (1943).

Rather than dispute the facts in this case, petitioner

argues that he is entitled to exclude the full amount of
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discharged indebtedness, because he had no control over the

series of incidents that culminated in the discharge. To the

extent we understand petitioner's argument, it proceeds as

follows. He claims that, in 1994, he was forced to retire early

from his profession as a teacher and that, as a result of the

financial difficulties he encountered because of a reduced

pension, he defaulted on his payment obligations. According to

petitioner, the financial difficulties which ensued after his

retirement were a direct consequence of his arrest nearly 20

years earlier by two police officers who also served on the local

board of education——an arrest he calls unlawful and in violation

of his constitutional rights. Thus, in petitioner's view, the

improper actions by local authorities had caused him to realize

discharge of indebtedness income.

While we do not question the sincerity with which petitioner

asserts this view, there is no merit to his argument. Congress

did not create an exception to alleviate the kind of hardship

that petitioner describes, and we must apply the law as written. 

Accordingly, under section 61(a)(12), petitioner must include the

$31,525 discharge of indebtedness in gross income.

To reflect the foregoing and concessions by the parties,

Decision will be entered under

Rule 155.