                         T.C. Memo. 1997-298



                       UNITED STATES TAX COURT



2925 BRIARPARK, LTD., JAMES C. MOTLEY, TAX MATTERS PARTNER,
Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22320-94.                        Filed June 30, 1997.



     Alan L. Tinsley and Charles B. Koerth, for petitioner.

     Dennis M. Kelly, for respondent.



                         MEMORANDUM OPINION


     HAMBLEN, Judge:    Respondent issued a notice of final

partnership administrative adjustment (FPAA) to 2925 Briarpark,

Ltd. (Briarpark), and determined adjustments in Briarpark's

ordinary income, gains derived from dealings in property, and the
                                   - 2 -

partners' capital accounts for 1989.1         After concessions, the

issue for decision is whether the income realized from the

discharge of nonrecourse loans should be treated as gain derived

from dealings in property includable in gross income under

section 61(a)(3) or as discharge of indebtedness income within

the meaning of section 61(a)(12).

        This case was submitted without a trial pursuant to Rule

122.2       The stipulation of facts and the attached exhibits are

incorporated by this reference, and the facts contained therein

are found accordingly.

                                Background

        Briarpark is a Texas limited partnership whose principal

place of business, at the time of filing the petition, was

Houston, Texas.       Briarpark is subject to TEFRA provisions

contained in sections 6221 through 6233.         During 1989, the

partners in Briarpark were:

        Name                               Type of Partnership Interest

Janet Stein                                     General   partner
Robert Husmann                                  General   partner
William C. Motley                               General   partner
Billy G. Motley                                 General   partner
Jon D. Motley                                   General   partner
James H. Motley                                 General   partner

        1
      The FPAA was mailed to the tax matters partner and each of
the partners entitled to notice.
        2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the year at issue, and
Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -

James C. Motley                           General partner
David D. Livingston, as trustee           Limited partner


James C. Motley (Mr. Motley) was a general partner and the tax

matters partner of Briarpark.

     During 1983 and 1984, Briarpark acquired a 3-acre parcel of

land at 2925 Briarpark Road (property) and constructed a 12-story

office building on the property.   Around September 27, 1983,

Briarpark borrowed $21,600,000 from InterFirst Bank Houston

(InterFirst) to finance the acquisition of the property and the

construction of the building (original loan).   Mr. Motley

executed a guaranty for principal, interest, penalties, expenses,

and fees due on the original loan.

     On May 28, 1987, Briarpark and InterFirst modified and

extended the original loan (modified loan) pursuant to a modified

loan agreement.   Under the agreement, Mr. Motley's obligation

under the guaranty was limited to $5 million, the original loan

was converted from recourse to nonrecourse, and the accrued but

unpaid interest in the amount of $3,100,000 was capitalized.     At

that time, InterFirst estimated that the fair market value of the

property was approximately $17 million.   Also on May 28, 1987,

Briarpark obtained a loan in the amount of $1,500,000 for tenant

improvements (build-out loan) on a nonrecourse basis.

     On April 15, 1988, Briarpark filed its U.S. Partnership

Return, Form 1065, for taxable year 1987.   Briarpark did not

report any income on its 1987 return with respect to the original
                               - 4 -

loan or the build-out loan.   Briarpark was not subject to an

examination by the IRS for the taxable year 1987.

     First Republic Bank Houston (First Republic) became the

successor in interest to InterFirst.   The Federal Deposit

Insurance Corporation, as receiver for First Republic, assigned

the modified loan and the build-out loan (the loans) to NCNB

Texas National Bank (NCNB or bank).

     During March 1989, Briarpark submitted an application to

NCNB seeking to modify the loans.   On March 15, 1989, Mr. Motley

submitted several similar proposals to NCNB regarding the sale of

the property.   In NCNB's view, the best proposal was one in which

the property would be sold for $12,700,000.

     As of July 1989, Briarpark was in default on the loans.      On

July 21, 1989, Briarpark signed a sale agreement to sell the

property to Dan Associates.   Dan Associates conditioned its

purchase of the property upon Briarpark's arranging the

satisfaction or removal of the encumbrances for consideration

paid to NCNB not in excess of $11,490,000.    On July 31, 1989,

NCNB agreed to release its liens to allow the sale of the

property to Dan Associates for $12,200,000 with the proceeds

being assigned to NCNB.

     On October 5, 1989, Briarpark and Dan Associates amended the

sale agreement.   Under the amended agreement, Briarpark was

required to arrange the satisfaction of the loans and removal of

the encumbrances for consideration not exceeding $11,036,000.      On
                                - 5 -

October 11, 1989, Mr. Motley's liabilities exceeded his assets by

$13,497,675.    On October 16, 1989, NCNB agreed to allow the cash

sale of the property for $11,600,000 and to settle with Mr.

Motley on his guaranty for $175,000.

     On November 3, 1989, Briarpark, Mr. Motley, Dan Associates,

and NCNB entered into a conditional release agreement (November

3, 1989 agreement).3   In the November 3, 1989 agreement, NCNB

agreed to release the property from all liens and security

interests upon satisfaction of the following conditions:    (1) The

sale of the property to Dan Associates for a minimum sale price

of $11,600,000, (2) the assignment of the sale proceeds to the

bank, (3) the transfer of Briarpark's cash reserves, and (4) the

payment of $175,000 by Mr. Motley to the Bank.

     On December 27, 1989, the outstanding balances of the

modified loan and the build-out loan were $24,562,763 and

$1,019,418, respectively.    Briarpark sold the property to Dan

Associates for $11,600,000.    Briarpark incurred selling expenses

of $554,901.    Dan Associates paid $10,936,532 of the proceeds to

NCNB.    The adjusted basis of the property was $11,661,245.   Also

on December 27, 1989, NCNB released the liens against the

property and released Mr. Motley from his guaranty of the

modified loan.    Mr. Motley paid $175,000 in cash to the bank.


     3
      The complete terms of the conditional release agreement
were not available, for a page of the agreement was missing from
the joint exhibit provided to the Court.
                                - 6 -

Briarpark transferred its cash reserves of $177,495 to NCNB.    As

of December 31, 1989, Briarpark had no assets and ceased business

operations.

     On its 1989 Federal partnership income tax return, Briarpark

reported cancellation of indebtedness income (COI income) of

approximately $14,468,154 as a result of the November 3, 1989,

agreement.    The reported amount is calculated as follows:

Modified loan balance                          $24,562,763
Build-out loan balance                           1,019,418
Total loan balance                              25,582,181
Less sale proceeds from Dan Associates         (10,936,532)
Less cash reserves paid to NCNB                   (177,495)
Net COI income                                  14,468,154
                                               ===========



                             Discussion

     The parties do not dispute that the loans were nonrecourse

during 1989.    The issue before us is whether the income realized

from the discharge of the loans should be treated as gains

derived from dealings in property includable in gross income

under section 61(a)(3) or as cancellation of indebtedness (COI)

income within the meaning of section 61(a)(12).

     Petitioner contends that the discharge of $14,468,154 of

Briarpark's modified and build-out loans (loans) by NCNB should

be characterized as COI income under section 61(a)(12).

Respondent argues that the entire balance of the loans must be

included in the amount realized and that the resulting gain is
                               - 7 -

taxable under section 61(a)(3).   Ultimately, we agree with

respondent.

     Petitioner bears the burden of proof on this issue.      Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Freytag v.

Commissioner, 904 F.2d 1011, 1017 (5th Cir. 1990), affg. 89 T.C.

849 (1987), affd. 501 U.S. 868 (1991).    For the first time on

brief, respondent increased Briarpark's amount realized by

$485,973, decreased its adjusted basis by $555,512, and deducted

its selling expenses of $554,901, thereby increasing Briarpark's

gains derived from dealings in property by $486,584.4   These

modifications result in an increased deficiency and are new

matters under Rule 142.   See Cox v. Commissioner, T.C. Memo.

1982-667.   Respondent did not assert an increased deficiency in

his answer.   Additionally, respondent did not move to conform the

     4
      In the notice of deficiency, respondent calculated the gain
derived from dealings in property as follows:

Amount realized                                $25,582,181
Less adjusted basis                            (11,661,245)
Gain                                            13,920,936
                                                ==========

     On opening brief, respondent calculated the amount realized

and the resulting gain as follows:

Cash proceeds from Dan Associates              $11,600,000
Debt discharged as a result of the sale         14,468,154
Total amount realized                           26,068,154
Less adjusted basis                            (11,105,733)
Less selling expenses                             (554,901)
Gain                                            14,407,520
                                                ==========
                                 - 8 -

pleadings to the proof.    Id.   If we were to allow respondent to

claim the increased deficiency for the first time on brief,

petitioner would be deprived of the opportunity to present

evidence to controvert whatever evidence respondent relies upon

to sustain his burden of proving the new matter.    Respondent is,

therefore, limited to the determination of gain contained in the

notice of deficiency.     Commissioner v. Transport Manufacturing &

Equip. Co., 478 F.2d 731 (8th Cir. 1973), affg. Riss v.

Commissioner, 56 T.C. 388 and 57 T.C. 469 (1971); Fox Chevrolet,

Inc. v. Commissioner, 76 T.C. 708 (1981); Rubin v. Commissioner,

56 T.C. 1155, 1163 (1971), affd. 460 F.2d 1216 (2d Cir. 1972).

     Gross income includes discharge of indebtedness, sec.

61(a)(12), and gains derived from dealings in property, sec.

61(a)(3).   Under section 61(a)(12), a taxpayer realizes income

when a creditor discharges nongratuitously all or a portion of a

taxpayer's debt.   Sec. 61(a)(12); sec. 1.61-12(a), Income Tax

Regs.

     For purposes of section 61(a)(3), section 1001 and the

regulations thereunder govern the method by which the amount of

gain or loss realized upon a sale or disposition of property is

calculated.   The amount of gain realized is the excess of the

amount realized over the taxpayer's adjusted basis in the

property, and the amount of loss realized is the excess of the

adjusted basis over the amount realized.    Sec. 1001(a).   The

"amount realized" is defined by section 1001(b) as the sum of any
                               - 9 -

money received plus the fair market value of the property

received.   Section 1.1001-2(a)(1), Income Tax Regs., further

defines "amount realized":

     Except as provided in paragraph (a)(2) and (3) of this
     section, the amount realized from a sale or other
     disposition of property includes the amount of
     liabilities from which the transferor is discharged as
     a result of the sale or disposition.

Various methods exist by which indebtedness may be satisfied,

each method producing a different tax consequence.     Danenberg v.

Commissioner, 73 T.C. 370, 381 (1979).   Whether the realized

income is gain on the disposition of property or COI income

depends on the particular facts.   Id.

     In the instant case, the sale of the property, the transfer

of cash of $177,495, and the assignment of the sale proceeds to

NCNB has the same practical effect as several other transactions

which have been held to be a "sale or exchange".     Helvering v.

Hammel, 311 U.S. 504 (1941) (holding that an involuntary

foreclosure sale of real estate was a sale or exchange); Allan v.

Commissioner, 856 F.2d 1169 (8th Cir. 1988) (treating the

taxpayer's reconveyance of property subject to nonrecourse debt

as a sale or exchange), affg. 86 T.C. 655 (1986); Yarbro v.

Commissioner, 737 F.2d 479, 483-485 (5th Cir. 1984) (holding that

an abandonment of real property subject to a nonrecourse debt was

an exchange; i.e., an act of giving one thing in return for

another thing regarded as equivalent), affg. T.C. Memo. 1982-675;

Laport v. Commissioner, 671 F.2d 1028 (7th Cir. 1982) (holding
                               - 10 -

the taxpayer's conveyance of property subject to nonrecourse debt

to the mortgagee by quitclaim deed in lieu of foreclosure was a

sale or exchange), affg. T.C. Memo. 1980-355; Middleton v.

Commissioner, 77 T.C. 310, 321 (1981) (holding the taxpayer's

abandonment of real property subject to nonrecourse debt was a

sale or exchange), affd. 693 F.2d 124 (11th Cir. 1982); Freeland

v. Commissioner, 74 T.C. 970 (1980) (holding the taxpayer's

conveyance of property encumbered by nonrecourse debt to the

mortgagee was a sale or exchange); Estate of Delman v.

Commissioner, 73 T.C. 15, 28 (1979) (holding repossession of

property subject to a nonrecourse obligation is to be treated as

a sale or exchange).

     The transaction before us is the functional equivalent of a

foreclosure, reconveyance in lieu of foreclosure, abandonment, or

repossession.    The same consequences flow from the November 3,

1989, agreement as in the cases cited supra p. 9:    the mortgagor

in each case is relieved of debt encumbering property and also is

relieved of the obligation to pay taxes and assessments against

the property.    Yarbro v. Commissioner, supra at 483; Laport v.

Commissioner, supra at 1032-1033; Freeland v. Commissioner,

supra.

     Any differences between the above transactions and the

transaction in the instant case are not in substance, but in

form.    For example, the fact that NCNB did not directly take

title to the property is immaterial.    See Sands v. Commissioner,
                               - 11 -

T.C. Memo. 1997-146 (holding that the discharge of nonrecourse

debt and release of ownership in the property that secured the

debt is a sale or exchange even though the mortgagee did not take

title to the property).

     Petitioner argues that the discharge of the loans by the

mortgagee falls under the purview of Gershkowitz v. Commissioner,

88 T.C. 984 (1987), and Rev. Rul. 91-31, 1991-1 C.B. 19.   In

Gershkowitz, several partnerships were involved in two identical

transactions.   Each partnership satisfied $250,000 of nonrecourse

loans with a cash payment of $40,000 but retained the property

securing the loans.   Each partnership obtained the funds to

settle the above loans by borrowing the $40,000 from another

lender on a nonrecourse basis and ultimately satisfying the

latter loan by transferring the encumbered property to the

lender.

     We held that the cancellation of the $250,000 of nonrecourse

loans without the surrender of the property securing those loans

resulted in COI income under section 61(a)(12) to the extent that

the canceled debt exceeded the cash payment.   Gershkowitz v.

Commissioner, supra at 1014.   With respect to each nonrecourse

loan of $40,000, we held that the entire outstanding balance of

the loan must be included in the amount realized in the

calculation of gain under section 1001.   Id. at 1016.

     Petitioner maintains that the facts are similar to those of

Gershkowitz in that NCNB agreed to discharge $25,582,181 of
                                 - 12 -

nonrecourse debt in exchange for a cash payment of $11,114,027 of

which only $177,495 was from petitioner's own funds and the

remaining $10,936,532 was the proceeds from the sale to Dan

Associates.   We disagree.     We recognized in Gershkowitz that the

tax consequences from the discharge of nonrecourse debt depend

upon whether the mortgagor transfers or retains the property

securing the debt and, accordingly, analyzed the tax consequences

of each debt separately.      The taxpayers in Gershkowitz discharged

the two loans in independent settlements, in one of which the

taxpayers retained the encumbered property and in the other of

which they did not.

     Petitioner would have us treat the cash sale and the

discharge of the loans as two independent events.      The record

before us, however, is replete with evidence that both loans were

discharged as a result of a single transaction involving the sale

of encumbered property.      NCNB conditioned the discharge of the

loans upon the sale of the property, and Dan Associates

conditioned the purchase upon that discharge.      At the end of the

day, NCNB had the proceeds from the sale, Dan Associates had the

property, and Briarpark was relieved of the entire balance of the

loans.   In the foregoing context, the arrangements among NCNB,

Dan Associates, and Briarpark embodied a single transaction to

sell the property securing the loans.      Accordingly, we must

conclude that Gershkowitz is not dispositive in the instant case.
                              - 13 -

     Petitioner's reliance on Rev. Rul. 91-31, supra, is also

flawed.   In Rev. Rul. 91-31, supra, the taxpayer purchased an

office building for $1 million.    In obtaining the purchase funds

from a third-party lender, the taxpayer executed a nonrecourse

note.   When the building's value dropped to $800,000, and the

outstanding principal on the note was still $1 million, the

lender agreed to modify the terms of the note's principal amount

to $800,000.   The Commissioner concluded that Commissioner v.

Tufts, 461 U.S. 300 (1983), and Gershkowitz v. Commissioner,

supra, required COI income to be recognized, pursuant to section

61(a)(12), to the extent the lender reduced the principal of the

undersecured, nonrecourse debt.    Rev. Rul. 91-31, supra, is

distinguishable because the facts therein did not involve the

sale or exchange of the encumbered property.

     Petitioner maintains that NCNB agreed to the discharge and

cash sale because it was in the bank's best interests rather than

as an accommodation to Briarpark.   The fact that NCNB, as a

profit-oriented entity, acted for economic reasons and agreed to

the transaction herein is not a sufficient basis for altering the

character of the gain realized by Briarpark on the transaction.

     Petitioner argues that the amount realized includes

nonrecourse debt only if the purchaser assumes that debt.   In

support of his position, petitioner relies upon Commissioner v.

Tufts, supra; section 1.1001-2(a), Income Tax Regs; and section

1.1034-1(b)(4), Income Tax Regs.    In Tufts, the Supreme Court
                               - 14 -

held that when a taxpayer sells or disposes of property subject

to nonrecourse debt in an amount in excess of its fair market

value, it must include in the amount realized the balance of the

nonrecourse debt even if such amount exceeds the fair market

value of the transferred property.      Even assuming that Dan

Associates did not take the property subject to the modified and

build-out loans, we do not agree that Tufts was intended to limit

the liabilities included in the amount realized to only those

assumed by a third-party purchaser.      The holding in Tufts focused

on the amount, not the character, of the gain or loss.      Moreover,

its rationale supports respondent's position in the instant case

to the extent that the concept of "amount realized" for computing

gain or loss may be equated with the concept of consideration for

"sale or exchange" purposes.   Commissioner v. Tufts, supra;

Yarbro v. Commissioner, 737 F.2d at 484.

     Moreover, we are not persuaded that the regulations cited by

petitioner include nonrecourse debt in the amount realized only

if the purchaser assumes such debt.      Section 1.1001-2(a), Income

Tax Regs., provides that the amount realized includes

"liabilities from which the transferor is discharged as a result

of the sale or disposition."   There is no mention of a

requirement that the purchaser must assume the debt for the debt

to be discharged as a result of a sale or disposition.

Petitioner's argument under section 1.1034-1(b)(4) Income Tax

Regs., is equally unpersuasive.   Section 1034 requires a taxpayer
                               - 15 -

to defer recognition of gain realized on the sale of the

taxpayer's principal residence in certain circumstances.   We are

not concerned with a residence in the case before us.   Section

1.1034-1(b)(4), Income Tax Regs., is simply not relevant to

petitioner in this case.

     Additionally, petitioner argues that Liberty Mirror Works v.

Commissioner, 3 T.C. 1018 (1944), supports his contention that a

mortgagor realizes COI income when a lender agrees to discharge a

debt encumbering property and to release the accompanying debt in

exchange for the assignment of the proceeds from the sale of the

property.    Petitioner's reliance on Liberty Mirror also is

misplaced.   In Liberty Mirror, the bank held a mortgage on the

taxpayer's property to secure a loan.   As part of its settlement

with the bank, the taxpayer agreed to forward the proceeds from

the sale of the property to the bank.   Because the taxpayer's

debt exceeded the proceeds from the sale, the bank agreed to

cancel the taxpayer's remaining indebtedness.   This Court held

that the cancellation of the taxpayer's remaining indebtedness

constituted a gift5 and that, consequently, the taxpayer realized

no income.   Although the facts there bear some similarity to

those of the instant case, it does not help petitioner because in

     5
      The precedential value of the gift rationale, as
articulated by the Supreme Court in Helvering v. American Dental
Co., 318 U.S. 322 (1943), and followed by this Court in Liberty
Mirror Works v. Commissioner, 3 T.C. 1018 (1944), has been
curtailed by subsequent authority, including Commissioner v.
Jacobson, 336 U.S. 28 (1949).
                                - 16 -

Liberty Mirror we did not consider the character of the

nonexistent income.    Danenberg v. Commissioner, 73 T.C. at 383.

Thus, we are satisfied that the discharge of the loans, the

transfer of the property, and the assignment of the sale proceeds

constitute a single integrated sale or exchange.

     Alternatively, petitioner argues that Briarpark realized

$9,200,000 of COI income in 1987 when InterFirst and Briarpark

agreed to convert the outstanding balance of the original loan,

which exceeded the fair market value of the property, from

recourse to nonrecourse debt.

     Whether a debt has been discharged is dependent upon the

substance of the transaction.    Cozzi v. Commissioner, 88 T.C.

435, 445 (1987).    A debt is considered to be discharged at the

point when it becomes clear that the debt will never have to be

paid.   Id.   In deciding when such a moment occurs, we must

consider the actions of the parties together with other facts and

circumstances relating to the likelihood of payment.    Id.    Any

identifiable event that fixes with certainty the amount to be

discharged may be taken into consideration.    Id. (citing United

States v. S.S. White Dental Manufacturing Co., 274 U.S. 398

(1927)).

     The existence of a faint possibility that a debt may be

collected does not prevent the recognition of COI income.

Exchange Sec. Bank v. United States, 492 F.2d 1096, 1099 (5th

Cir. 1974); cf. Fidelity-Philadelphia Trust Co. v. Commissioner,
                                - 17 -

23 T.C. 527, 531 (1954).    The fact that a creditor has failed to

remove a debt from its books does not mean that the debt has not

been canceled.   Exchange Sec. Bank v. United States, supra.

     Based upon the principles set forth above, we must conclude

that an identifiable event fixing with certainty the discharge of

part of the original loan did not occur in 1987.    At the same

time they modified the original loan, InterFirst agreed to

provide Briarpark the additional build-out loan in the amount of

$1,500,000 for tenant improvements.

     We are not convinced that converting the undersecured

original loan from a recourse to a nonrecourse debt constitutes

an identifiable event.     See Zappo v. Commissioner, 81 T.C. 77, 87

(1983).   Petitioner has not established that the conversion of

the debt made it highly unlikely, or impossible to estimate,

whether and when the debt would be repaid.     Commissioner v.

Tufts, 461 U.S. 300 (1983); Gibson Prods. Co. v. United States,

637 F.2d 1041, 1047 (5th Cir. 1981).     In our view, InterFirst's

willingness to make the build-out loan indicates its belief that

the tenant improvements would increase the value of the property.

Moreover, InterFirst increased the lien securing the original

loan according to the agreed modifications.    Such actions are not

consistent with discharging the loan.    The totality of the

circumstances leads us to believe that InterFirst still intended

to enforce its rights in 1987.    In addition, petitioner does not

point to any identifiable event indicating Briarpark's
                                - 18 -

abandonment of the property in 1987.     Accordingly, we are

satisfied that Briarpark did not realize COI income of $9,200,000

in 1987.

     Having found that Briarpark discharged the loans as a result

of the sale in 1989, we turn to consider the effect of that

determination upon the characterization of Briarpark's income.

The amount realized on the sale, exchange, or disposition of

property encumbered by nonrecourse debt includes the entire

balance of the obligation.    Commissioner v. Tufts, supra; Crane

v. Commissioner, 331 U.S. 1 (1947); Lockwood v. Commissioner, 94

T.C. 252 (1990).   In this case, section 61(a)(12) has no

application to a sale or exchange of property subject to

nonrecourse liabilities.     Estate of Delman v. Commissioner, 73

T.C. 15 (1979).

     In sum, we hold that the disposition of the property

constitutes a sale or exchange for purposes of section 1001 and

the regulations thereunder and that the income Briarpark realized

must be characterized as gain derived from dealings in property

under section 61(a)(3).    We have considered all of the other

arguments and, to the extent we have not addressed them, find

them to be without merit.

     To reflect the foregoing,

                                           Decision will be entered

                                      under Rule 155.
