Court Opinion

ID: 4485197
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:17:14.371472+00
Date Added: 2024-06-11T14:53:46.949196
License: Public Domain

OPINION Goffe, Judge: The Commissioner determined a deficiency in petitioners’ Federal income tax for the taxable year 1977 in the amount of $4,492.18. This matter is before us on respondent’s motion for summary judgment. The facts are undisputed, petitioners’ having admitted the facts contained in respondent’s first request for admissions. The soie issue to be decided is whether a judgment for damages and costs which petitioners paid in 1977 is deductible as a theft loss under séction 165(c) or a capital loss under section 165(f).1  Petitioners, husband and wife, filed a joint Federal income tax return for the taxable year' 1977 with the Internal Revenue Service Center at Ogden, Utah. They resided in Portland, Oreg., when they filed their petition. In 1977, petitioner Ferris F. Boothe2 paid a judgment of $20,000 in damages and $792.25 in court costs rendered against him. The judgment arose from his sale, in 1960, of Soldier’s Additional Homestead Rights (hereinafter referred to as the rights). Petitioners claimed the $20,000 (less the first $100 not allowable) payment as a theft loss and the $792.25 as a miscellaneous deduction. The Commissioner, in the statutory notice of deficiency, disallowed the deductions but allowed $20,792 as a long-term capital loss on the ground that petitioners failed to establish that a theft occurred or that a deductible loss was sustained in 1977. The rights which gave rise to the litigation against petitioner were granted to certain soldiers who served during the Civil War who had homesteaded land. Sec. 2306, U.S. Rev. Stat. The rights are freely assignable and permit the holder to apply for and to receive a fee interest in certain Federal lands. In 1958, a central registration for these rights was first established and "scrip abstracts” reflecting chain of title were gradually prepared 5 or 6 years subsequent to establishment of the central registration. William H. Dooley, Jr., served as a soldier in the Civil War in Company "I” of the 18th Missouri Infantry from December 9, 1864, to June 18, 1865, and by reason of his homestead in Arkansas became entitled to apply for rights to 120 acres under section 2306, U.S. Rev. Stat. In 1873, Dooley perfected his rights by filing the appropriate application with the U.S. General Land Office. On September 28,1898, Dooley assigned his rights to acquire 120 acres to Lewis C. Black. On April 29, 1916, Dooley again sold his rights to acquire 120 acres to B. A. Mason in three separate assignments, conferring the right to acquire 40 acres each. These assignments were executed in the State of Arkansas. On April 6, 1951, B. A. Mason sold the right to acquire 40 acres of the rights he acquired from Dooley to Ad Given Davis, who died on November 11, 1956. Petitioner purchased the rights to acquire 40 acres from Davis’ estate for $4,400 on April 27, 1959. The assignment contained the following provision: in the event the Bureau of Land Management of the United States Department of the Interior refuses to validate the aforesaid right as valid and useable for the acquisition of public land under and pursuant to [applicable statutes], then upon re-assignment by assignee revesting title thereto in assignor, assignor shall refund the purchase price paid therefor in full to assignee; provided, that notice is furnished and said right is tendered back to assignor by assignee not later than December 31, 1959. On June 30,1960, petitioner sold his interest in the rights to 40 acres to R. L. Spoo for $8,000 who designated as the assignee William N. McDonald Co. Petitioners reported gain from the sale of the rights as long-term capital gain. Prior to the sale, petitioner sought to exercise the rights in the State of Washington but was unable to do so because the Federal lands he desired were not available for entry based upon the rights he held. At the time he sold the rights, however, petitioner had no notice or knowledge of the validity or invalidity of the rights. The assignee of petitioner’s rights changed its name to Metropolitan Mortgage & Security Co. and assigned the rights to Douglas Land Co., which first sought to exercise the rights on land in Nevada. The Bureau of Land Management held that such land was not subject to entry by these rights but that the rights themselves were valid. Douglas Land Co. then sought to exercise its rights to land in Oregon, and the Bureau of Land Management held the rights to be invalid based upon the earlier assignment of them from Dooley to Black. Litigation against petitioner for breach of warranty of title ensued which resulted in a judgment of $20,000 in damages and $792.25 in court costs being awarded against petitioner. The judgment against petitioner paid the judgment to R. L. Spoo, on October 26, 1977. Petitioners contend that they sustained a theft loss under the law of Arkansas, and respondent contends that petitioner was not the victim of a theft and, therefore, not entitled to a deduction for theft loss. The deductions claimed by petitioners were for a judgment of damages and court costs. The inquiry as to the character of the deduction should, therefore, focus upon the nature of the litigation. Where litigation involves the acquisition or disposition of capital assets, the origin and character of the claim is the controlling test. Woodward v. Commissioner, 397 U.S. 572 (1970); United States v. Hilton Hotels Corp., 397 U.S. 580 (1970). The cost of defending or perfecting title to property is a capital expenditure. Sec. 1.263(a)-2, Income Tax Regs. Although most of the cases involving this issue relate to deductibility under section 162 or section 212, there is no reason why the test should not be applied to a deduction claimed under section 165. The application of the origin-of-the-claim test in Woodward and Hilton must consider "the issues involved, the nature and objectives of the litigation, the defenses asserted, the purpose for which the claimed deductions were expended, the background of the litigation, and all the facts pertaining to the controversy.” Boagni v. Commissioner, 59 T.C. 708, 713 (1973); Estate of Baier v. Commissioner, 63 T.C. 513, 520 (1975), affd. 533 F.2d 117 (3d Cir. 1976). Quite plainly, the "origin-of-the claim” rule does not contemplate a mechanical search for the first in the chain of events which led to the litigation but, rather, requires an examination of all the facts. The inquiry is directed to the ascertainment of the "kind of transaction” out of which the litigation arose. [Boagni v. Commissioner, supra at 713; fn. ref. omitted.] It is undisputed that the litigation arose from petitioner’s sale of his rights to R. L. Spoo. The legal action was instituted against petitioner because the rights which he purported to convey were invalid and worthless. If petitioner had not attempted to sell the rights, the litigation would not have ensued. The issue in the litigation was whether petitioner was liable for damages in conveying title to the rights which title he did not possess. We recognize that the defect in title was occasioned by a probable fraud perpetrated against petitioner’s predecessor in title, yet, in the litigation, petitioner was defending himself against an alleged breach of his warranty of title to Mr. Spoo. The origin-of-the-claim test is applicable to the disposition of property as well as the acquisition of property. Helgerson v. United States, 426 F.2d 1293, 1297 (8th Cir. 1970). In Arrowsmith v. Commissioner, 344 U.S. 6 (1952), the taxpayers received payments in liquidation of their corporation. Subsequent to reporting capital gains from the liquidation, a judgment was rendered against the corporation which judgment petitioners paid. The Supreme Court held that the payments by the taxpayers were allowable only as capital losses because they arose from the earlier capital transaction. We conclude that the principle of Arrowsmith applies here.3  In Shannonhouse v. Commissioner, 21 T.C. 422 (1953), the taxpayers purchased real property and buildings which they subsequently sold. It was later discovered that one of the buildings encroached upon adjoining property of a third person. The purchasers of the property from the taxpayers spent $3,331.50 to relocate the building for which the taxpayers reimbursed them to be relieved of further liability for breach of warranty of title. We held that the reimbursement by the taxpayers was capital in nature, being an outgrowth of the sale of the property by the taxpayers. In the instant case, petitioner purchased a bundle of rights from the Davis estate. He sold those rights, albeit invalid as they were. The judgment and costs which petitioner paid in 1977 resulted from the sale of rights which were defective. In principle, we find Shannonhouse to be indistinguishable. Moreover, in Rees Blow Pipe Manufacturing Co. v. Commissioner, 41 T.C. 598 (1964), affd. 342 F.2d 990 (9th Cir. 1965), our reliance upon Shannonhouse and Arrowsmith in holding that judgments and court costs were capital in nature when they relate to the sale of a capital asset was specifically approved. We, accordingly, hold that the judgment and court costs paid by petitioner in 1977 are allowable as a long-term capital loss. In view of our holding based upon the origin-of-the-claim test, it is unnecessary for us to decide whether a taxpayer who is not the direct victim of a theft is entitled to deduct a theft loss. An appropriate order and decision will be entered. Reviewed by the Court. Dawson, Simpson, Sterrett, Wiles, Parker, Shields, Cohen, Swift, and Jacobs, JJ., agree with the majority opinion.   All section references are to the Internal Revenue Code of 1954 as amended and in effect during 1977.    "Petitioner” will hereinafter refer to petitioner Ferris F. Boothe.    Kisska v. Commissioner, T.C. Memo. 1981-655; Clay v. Commissioner, T.C. Memo. 1981-375.