Cottage Savings Ass'n v. Commissioner
Cottage Savings Association v. Commissioner, 499 U.S. 554 (1991), was an income tax case before the Supreme Court of the United States. The Court was asked to determine whether the exchange of different participation interests in home mortgages by a savings and loan association was a "disposition of property" under § 1001(a) of the Internal Revenue Code (since this was the requirement for them to realize, and deduct, their losses on these mortgages). The Court determined that it was a "disposition of property" by making the following three holdings: Background. Cottage Savings Association was a savings  & loan association (S&L) serving the Greater Cincinnati area. Like many other S&L's, Cottage Savings had a large number of long-term, low-interest mortgages on its books, which declined in value as interest rates increased during the late 1970s. These S&Ls could have achieved a tax savings from selling these mortgages at a loss, but they were dissuaded from doing so because the accounting regulations of the Federal Home Loan Bank Board (FHLBB) would have required them to report these losses on their books, possibly putting them into insolvency. Hoping to find another way for these S&Ls to realize  their tax losses, the FHLBB promulgated a new regulation called "Memorandum R-49", under which the S&Ls would not have to show a loss on their books if they exchanged their mortgages for "substantially identical" mortgages held by other lenders. Cottage Savings made a transaction pursuant to this regulation by exchanging 90% participation interests in 252 mortgages to four other S&Ls, receiving in return 90% participation interests in 305 mortgages. All the mortgages involved in the transaction were for homes in the Greater Cincinnati region. The fair market value of the interests exchanged by each side was approximately $4.5 million . The face value of the interests which Cottage Savings relinquished was approximately $6.9 million. On its 1980 federal income tax return, Cottage Savings claimed a loss of $2,447,091, the adjusted difference between the face value of the participation interests it gave up and fair market value of the interests it received. The Commissioner of Internal Revenue disallowed Cottage Savings' deduction, so the S&L filed a petition for redetermination in the United States Tax Court, which reversed the Commissioner's decision and permitted the deduction. The Commissioner appealed to the United States Court of Appeals for the Sixth Circuit , which reversed the decision of the Tax Court, holding that even though Cottage Savings realized a loss in the transaction, it had not actually realized the loss during the 1980 tax year. The U.S. Supreme Court then granted certiorari. Issues. § 1001(a) of the Internal Revenue Code requires that the tax consequences of a gain or loss in property value be deferred until it is realized by "the sale or other disposition of property". Since the transaction was certainly not a sale, the Court identified the main legal issue to be whether the exchange was a "disposition of property." Thus, to  determine whether the exchange was a "disposition of property," the court first had to determine whether §1001 incorporated a "material difference" requirement, and if so, what that requirement involved. Opinion of the Court. In an opinion by Justice Marshall, the Court came to three key findings: Material difference is a requirement for a disposition under §1001. Justice Marshall cited Treasury Regulation §1.1001-1 (), which required that an exchange of materially different properties constitutes a realization under the Tax Code. Congress delegated to the Commissioner the authority to make rules and regulations to enforce the Internal Revenue Code. Because Title 26  of the Code of Federal Regulations represents the Commissioner's interpretation of the Code, the Court deferred to the Commissioner's judgment, holding that the regulation was a reasonable interpretation of the Code and consonant with prior case law. Material difference defined. Justice Marshall defined what constituted a "material difference" in property under §1001 by examination at what point "realization" had been found in past case law. He started with "Eisner v. Macomber" (1920), which dealt with exchange of stock in corporations. In several cases after "Eisner", the court held that an exchange of stock which occurred when a corporation  reorganized in another state was a realization, because corporations have different rights and power in different states. Marshall reasoned that properties materially differ for tax purposes when their respective possessors enjoy different legal entitlements from each. As long as the properties being exchanged were not identical, a realization had taken place. This was a simpler, black letter rule, as compared to what the Commissioner was arguing for, which would have examined not just the underlying substance of the transaction, but also the market and other non-tax regulations. The properties exchanged were "materially different." Justice Marshall held that the participation  interests exchanged by Cottage Savings and the other S&Ls were "materially different" because the loans involved were made to different obligors and secured by different properties. Even though the interests were "substantially identical" for the FHLBB's purposes, that did not mean they were not materially different for taxation purposes. Therefore, the exchange was a "disposition of property," Cottage Savings had realized a loss, and their deduction was appropriate. Dissent. Justice Blackmun dissented, joined by Justice White. Academic Commentary. The emphasis in "Cottage Savings" on realization as an administrative requirement makes evident the capricious role that realization plays in the  tax field.