In Uncategorized on 05/23/2013 at 08:24

Judge Laro has scant sympathy for James S. Callahan and Carol S. Callahan in 2013 T. C. Memo. 131, filed 5/22/13.

It’s an oft-recurring scenario following the Great Real Estate Debacle of 2007. Carol had two dwellings, the New Jersey home she got from Papa and the FL condo she bought with Mama and inherited as Mama’s demise. They were both mortgaged and both in foreclosure.

Carol fell in with thieves, namely Ronnie (the Ganef–an arcane technical term) Losner, who pulled the now-clichéd home equity theft game on both properties. Carol sells both to Ronnie’s shills, who finagle fresh mortgages to pay off the old defaulted one, and gets a short-term lease from the shills at a ruinous rent, with an option to buy back her properties.

Ronnie the Ganef gets disbarred, and while Judge Laro takes judicial notice of the NY proceeding, he can’t see how that helps Carol.

Carol sues in NJ and the NJ court voids the sale; Carol claims NJ voided it ab initio, and she paid off the fresh mortgage, but Judge Laro says no. The NJ court left the fresh mortgage, which Carol later paid off, in place. “The fact that the Chancery Court voided the transfers subject to Chase’s existing mortgage suggests that the court was mindful that voiding the transactions from the beginning could nullify all transactions that followed the initial transfers, including the mortgaging of the property by Chase as a successor to Washington Mutual. Implicit in the Chancery Court’s order voiding the transfers subject to the existing mortgage was that Chase’s mortgage interest in the property was valid. As a corollary, the Chancery Court did not void the transfers from the beginning.” 2013 T. C. Memo 131, at p. 23.

Anyway, IRS wasn’t a party to the NJ proceeding, IRS isn’t in privity with Carol or the crooks or the banks, so IRS isn’t bound by any of this.

I don’t know what was pleaded or proved in the NJ case, and anyway I’m not admitted in NJ, but shouldn’t Carol have argued that the whole thing should be set aside, Chase could look to its title insurer on the mortgage, and the insurer subrogate and sue Ronnie and the shills?

Howbeit, Carol admits she had capital gains on both mortgage payoffs, even if fraudulently obtained, but not as much as IRS claims.

Judge Laro agrees, up to a point. IRS claimed that Carol recognized income on each sale to the shills at the full stated purchase price. No, said Judge Laro, the shills made sure she got nothing except some cash to prepay the phony rent on her lease from the shills, some expenses like real estate taxes, and the cancellation of her personal liability on the old defaulted mortgage. I respectfully refer the reader to the text of the decision for the arithmetic.

But the gain is ordinary, not capital.

Judge Laro: “In their brief petitioners appear to be claiming that any debt cancellation income is considered capital gain income. The amount realized on the sale of property that secures a recourse liability, however, does not include amounts that are (or would be if realized and recognized) income from the discharge of that liability under section 61(a)(12). Sec. 1.1001-2(a)(2), Income Tax Regs.; see also Commissioner v. Tufts, 461 U.S. 300, 318-320 (1983) (O’Connor, J., concurring) (noting Commissioner’s longstanding position reflected in section 1.1001-2, Income Tax Regs.). Income realized on the discharge of such debt is ordinary income taxed at ordinary rates.” 2013 T. C. Memo. 131, at pp. 28-29.

And Section 108(h), with its relief from relief as to qualified principal residence indebtedness doesn’t help poor Carol. “The record before us does not support such claim. There is no evidence showing any part of Ms. Callahan’s original 1998 purchase price of $437,500 was financed with a mortgage loan that was then refinanced with the Wall Street note in December 2005. The record also does not show Ms. Callahan used any of the proceeds from the Wall Street note to finance the construction or substantial improvement of the New Jersey property or to refinance a debt that she incurred for such construction or improvement. Thus, the record does not support a conclusion that any portion of the Wall Street note was qualified principal residence indebtedness within the meaning of section 108(a)(1)(E). See sec. 108(h)(2).” 2013 T. C. Memo. 131, at p.  30.

Judge Laro cuts Carol some slack, in that some of the debt may be home equity indebtedness, and lets her deduct interest to the extent of the $100K limit (see my blogposts “Sophy’s Choice”, 3/6/12 and “Faina, Meet Sophy”, 5/17/12).

So Carol ends up in much the same straits as an earlier person who fell in with thieves.

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