Opinion ID: 399155
Heading Depth: 3
Heading Rank: 2

Heading: The Treasury Regulation

Text: 43 As noted above, the statute provides that (a)ny amount realized ... with respect to (foreclosure) property shall be handled through adjustments to the bad debt reserve. I.R.C. § 595(b). The regulation interprets this as amounts representing a recovery of capital. Treas. Reg. § 1.595-1(e)(6). 44 The regulation is an interpretive regulation interpreting the phrase any amount realized. Although the regulation was promulgated pursuant to the grant of authority in I.R.C. § 595(d), the grant of authority is a general one. It does not authorize the Commissioner to define a statutory term or prescribe a method of executing a statutory provision. See United States v. Vogel Fertilizer Co., supra, --- U.S. at ----, 102 S.Ct. at 827; Rowan Cos. v. United States, supra, --- U.S. at ----, 101 S.Ct. at 2292, 68 L.Ed.2d at 821. Deference is particularly appropriate to this interpretive regulation, since Congress used such general language as to render an interpretive regulation appropriate. See United States v. Vogel Fertilizer Co., supra; National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 476, 99 S.Ct. 1304, 1306, 59 L.Ed.2d 519 (1979). The phrase any amount realized is not self-defining. It must be interpreted in light of its origin and purpose. See United States v. Correll, 389 U.S. 299, 304 & n.16, 88 S.Ct. 445, 448, 19 L.Ed.2d 537 (1967). We review the regulation to determine whether it is a reasonable interpretation of the statute's plain language, its origin, and its purpose. United States v. Vogel Fertilizer Co., supra; National Muffler Dealers Ass'n v. United States, supra, 440 U.S. at 477, 99 S.Ct. at 1307. A Treasury regulation is not invalid simply because the statutory language will support a contrary interpretation. United States v. Vogel Fertilizer Co., supra. The regulation only need implement the congressional mandate in some reasonable manner. United States v. Vogel Fertilizer Co., supra (quoting United States v. Correll, supra, 389 U.S. at 307, 88 S.Ct. at 449). 45 Congress authorized the Commissioner to prescribe such regulations as he may deem necessary to carry out the purposes of this section. I.R.C. § 595(d). The purpose of the section was to telescope foreclosure, purchase, and resale into one taxable event, treat post-foreclosure receipts as payments on the indebtedness, and treat the foreclosed property as having the same characteristics as the debt for which it was security. S.Rep.No. 1881, 87th Cong., 2d Sess. 47 (1962), reprinted in 2 Legislative History of the Revenue Act of 1962, at 2,405 (1967). There is nothing in the legislative history indicating that Congress specifically intended that recovery of accrued but unpaid interest should be treated as a credit to the bad debt reserve. 46 At least to the extent that it provides that receipt of accrued but unpaid interest is not credited to the bad debt reserve, the regulation harmonizes with the statute's plain language, origin, and purpose. The regulation carries out Congress' purpose of adjusting the bad debt reserve to reflect the lender's ability to recover its basis. It preserves the distinction in prior law that receipt of interest is income and not a recovery of principal or a capital asset. See Maass v. Higgins, 312 U.S. 443, 447, 61 S.Ct. 631, 633, 85 L.Ed. 940 (1941); Commissioner v. Morgan, 272 F.2d 936, 939 (9th Cir. 1959); United States v. Snow, 223 F.2d 103, 109 n.3 (9th Cir.), cert. denied, 350 U.S. 831, 76 S.Ct. 64, 100 L.Ed. 741 (1955). 47 Our decision is not inconsistent with First Federal Savings & Loan Ass'n v. United States, 660 F.2d 767 (Ct.Cl.1981). In that case the Court of Claims held that rents received by a savings and loan association during the period between foreclosure and sale are not ordinary income, but are credits to the bad debt reserve. The Court of Claims struck down the Commissioner's interpretation, expressed in Treas. Reg. § 1.595-1(e)(6), that only amounts representing a recovery of capital are treated as credits to the bad debt reserve. The court found this interpretation inconsistent with section 595 to the extent that it prevented treating receipt of rents as a credit to the bad debt reserve. 660 F.2d at 770. The court felt that this result was required in that case because Congress explicitly forbade savings and loan associations to take a depreciation deduction. Id. at 769. Ordinarily, where rental income is treated as ordinary income, a depreciation deduction is permitted. The court concluded that Congress did not intend to alter this general rule and therefore would not require a taxpayer to take the rents into account as ordinary income if no depreciation deduction were permitted. 48 In our case, as noted above, the general rule is that interest is ordinary income. There is no indication from Congress that it intended to alter this rule. No principles of taxation or fairness require that recovery of accrued but unpaid interest be treated as a credit to the bad debt reserve. 1 49 Our result is also fully consistent with Allstate Savings & Loan Ass'n v. Commissioner, supra. Because the expenses of selling the foreclosed property are inherently capital in nature, 68 T.C. at 320, recovery of those expenses is a recovery of capital. It is therefore credited to the bad debt reserve. Receipt of interest is not a recovery of capital. It is therefore fully consistent not to treat it as a credit to the bad debt reserve, but as ordinary income. 50 Permitting a taxpayer to recover interest without recognizing ordinary income would mean that taxpayers would be treated differently solely because of the accounting method they use. Of course courts should be slow to attribute to Congress a purpose producing such unequal treatment among taxpayers, resting on no rational foundation. United States v. Gilmore, 372 U.S. 39, 48, 83 S.Ct. 623, 628, 9 L.Ed.2d 570 (1963). 51 An accrual method taxpayer recognizes interest as it accrues. It will therefore take ordinary income at the time the payment is due. The amount previously reported as accrued interest is applied to the taxpayer's basis in the property. Consequently, all that it receives when it sells the foreclosure property is a recovery of capital. Treas. Reg. § 1.595-1(d). Any recovery of that interest from sale of the property cancels out this increase in basis, and no credit is assigned to the bad debt reserve. 52 If the recovery of accrued but unpaid interest by a cash method taxpayer is not treated as ordinary income, the cash method taxpayer will take a nontaxable credit to its bad debt reserve. This credit may or may not reduce the taxpayer's bad debt deduction in a later year. 2 The cash method taxpayer at least defers the gain. A mere difference in choice of accounting method should not have such significant consequences, absent some clear indication to the contrary. See United States v. Snow, supra, 223 F.2d at 109 n.3. 53 The regulation does not provide that all sales proceeds of section 595 property constitute a recovery of capital unless treated as interest under local law. The reference to applicable local law refers only to payments on a deficiency judgment. Treas. Reg. 1.595-1(e)(6). The reference to local law is contained within parentheses in a phrase separated by commas from two other distinct phrases. Another parenthetical in the regulation clearly refers only to the clause of which it is a part. In construing statutes, qualifying phrases are generally applied to the immediately preceding phrase and not to phrases more remote. Azure v. Morton, 514 F.2d 897, 900 (9th Cir. 1975). 54 The regulation also does not provide that the only amount not treated as a return of capital on sale of section 595 property is a collection on a deficiency judgment that is treated as interest under local law. Interpreting the regulation in that manner would render ineffective the limitation that only amounts representing a recovery of capital are credited to the bad debt reserve. The examples given in the regulation do not override this general rule. Construction which gives effect to all of the words of a statute or regulation is preferred over an interpretation which renders some of the statute or regulation ineffective. Hughes Air Corp. v. Public Utilities Comm'n, 644 F.2d 1334, 1338 (9th Cir. 1981). 55 We conclude that the phrase recovery of capital is not ambiguous. It sufficiently states that amounts which do not represent a recovery of principal or basis, such as the amount attributable to accrued interest here, are not treated as a credit to the bad debt reserve.