
USCA1 Opinion

	




                            UNITED STATES COURT OF APPEALS                                FOR THE FIRST CIRCUIT                                                                                      ____________________        No. 96-1053                        CARLOS J. QUIJANO AND JEAN M. QUIJANO,                                     Appellants,                                          v.                              UNITED STATES OF AMERICA,                                      Appellee.                                                                                      ____________________                     APPEAL FROM THE UNITED STATES DISTRICT COURT                              FOR THE DISTRICT OF MAINE                       [Hon. Gene Carter, U.S. District Judge]                                          ___________________                                                                                      ____________________                                        Before                                 Cyr, Circuit Judge,                                      _____________                            Aldrich, Senior Circuit Judge,                                     ____________________                          and Gertner,* U.S. District Judge.                                        ___________________                                                                                      ____________________             Paula  N.  Singer, with  whom  Robert  S.  Grodberg and  Vacovec,             _________________              ____________________      ________        Mayotte & Singer were on brief for appellants.        ________________             Kenneth  W.  Rosenberg,  Attorney,  Tax Division,  Department  of             ______________________        Justice, with whom Jay P.  McCloskey, United States Attorney,  Loretta                           _________________                           _______        C. Argrett,  Assistant Attorney  General,  Gary R.  Allen and  Richard        __________                                 ______________      _______        Farber, Attorneys,  Tax Division, Department of Justice, were on brief        ______        for appellee.                                                                                      ____________________                                   August 21, 1996                                                                                      ____________________                                    ____________________             *Of the District of Massachusetts, sitting by designation.                    CYR, Circuit Judge.   Appellants Carlos J.  and Jean M.                    CYR, Circuit Judge.                         _____________          Quijano, husband  and wife, appeal  from a  district court  order          rejecting  their  joint claim  for  a federal  income  tax refund          relating  to the  1990 sale  of  their residence  located in  the          United Kingdom.  We affirm the district court judgment.                                          I                                          I                                      BACKGROUND                                      BACKGROUND                                      __________                    Appellants,  United  States taxpayers,  acquired  their          residence for 297,500 pounds sterling on September 30, 1986.  The          entire purchase  price was  financed through  a mortgage  loan in          pounds  sterling.   On  October  12, 1988,  it  was increased  to          330,000 pounds (exchange rate:   $1.73 to 1 pound); on  March 27,          1990,  to  333,180  pounds  (exchange  rate  $1.62 to  1  pound).          Ultimately,  their  capital improvements  to  the residence  cost          45,647 pounds.   No  U.S. funds were  used either to  purchase or          improve the residence.  On July 27, 1990, it was sold for 453,374          pounds,  net  of selling  expenses,  and  the mortgage  loan  was          retired.                     Appellants'  1990  joint   federal  income  tax  return          originally  reported  a  $308,811  capital  gain,  utilizing  the          exchange rate at date of purchase ($1.49 to 1 pound) to calculate          the  adjusted cost basis, but using  the exchange rate at date of          sale ($1.82  to 1 pound) to calculate the sale price.  Appellants          later amended their 1990 return to claim a $30,610 refund arrived          at  by utilizing the  exchange rate at  date of sale  ($1.82 to 1          pound) to determine the adjusted cost  basis as well as the  sale                                          2          price, thus resulting in a reduced $199,491 capital gain.                     After  the Internal  Revenue  Service disallowed  their          amended refund  claim, appellants  initiated the  present action.          The complaint alleged that Revenue Ruling 90-79 misinterprets our          decision in Willard Helburn,  Ltd. v. Commissioner, 214 F.2d  815                      ______________________    ____________          (1st Cir. 1954), and that  the tax imposed violates the Sixteenth          Amendment,  see Eisner v. Macomber, 252 U.S.  189 (1920).  In due                      ___ ______    ________          course,  appellants moved for  summary judgment.   The government          responded  that the  total cost  basis of  the residence  must be          arrived  at by  utilizing  the  respective dollar-pound  exchange          rates  in  effect  when  the  residence  was  purchased and  each          capital-improvement payment  was  made.   The parties  stipulated          that,  thus  calculated,  appellants  had  overpaid  $2,668, plus          related  interest   and   penalties   not   presently   relevant.          Ultimately, the district court entered judgment for appellants in          the amount of  $2,668 plus interest and penalties  as provided by          law.   On appeal, appellants  challenge the district  court order          rejecting their motion for summary judgment in the larger  amount          of $30,610.                                            II                                          II                                     DISCUSSION1                                     DISCUSSION                                     __________                                        ____________________               1In a  civil action  for refund under  26 U.S.C.    7422(a),          "the taxpayer must bear the burden of proving that the challenged          IRS  tax assessment  was erroneous."   Webb  v. Internal  Revenue                                                 ____     _________________          Service of  the United States, 15  F.3d 203, 205 (1st  Cir. 1994)          _____________________________          (citing Lewis v. Reynolds, 284 U.S. 281, 283, 52 S. Ct. 145, 146,                  _____    ________          76 L.Ed  293, modified on other grounds, 284  U.S. 599, 52 S. Ct.                        ________ __ _____ _______          264, 76  L. Ed. 514  (1932)).  We  review the challenged  summary          judgment ruling  de novo.   McCabe v. Life-Line  Ambulance Serv.,                           __ ____    ______    ___________________________          Inc., 77 F.3d 540, 544 (1st Cir. 1996), petition for cert. filed,          ____                                    ________ ___ ____  _____                                          3                                                  ____________________          64 U.S.L.W. 3808 (U.S. May 29, 1996) (No. 95-1929).                                          4          A.   Foreign Exchange Transactions          A.   Foreign Exchange Transactions               _____________________________                    We  first  consider  the challenge  to  the  tax refund          calculation  arrived at  by  the  district  court  under  Revenue          Rulings 90-79 and  54-105.  Section 1011 of  the Internal Revenue          Code provides that the "adjusted basis for determining the gain .          .  . from  the sale  or other  disposition of  property, whenever          acquired, shall be  the basis (determined under section  1012 . .          .),  adjusted as provided  in section 1016."   26  U.S.C.   1011.          Under section 1012, generally the  basis of property is its cost.          Id.    1012.   For relevant  purposes, section  1016(a)(1) states          __          that  a proper adjustment shall be  made for "expenditures . . .,          or  other items, properly chargeable to  capital . . .  ."  Id.                                                                        __          1016(a)(1).                    Section 985(a) generally  requires that all  income tax          liability  determinations are  to  be  made  in  the  "taxpayer's          functional currency," id.   985(a),  which is the U.S. dollar for                                __          individual United  States taxpayers,  id.    985(b)(1)(A).   With                                                __          exceptions not relevant here, section 165(a) permits "a deduction          [for] any  loss sustained during the taxable year . . . ."  Id.                                                                        __          165(a).  Finally and importantly, in relevant part section 165(c)          limits the  deductions  available  to  individual  United  States          taxpayers to  "(1) losses incurred  in a trade or  business [and]          (2) losses incurred in  any transaction entered into for  profit,          though not  connected with a trade  or business .  . . ."   Id.                                                                        __          165(c).                 1.   Loss on Mortgage Loan Transaction               1.   Loss on Mortgage Loan Transaction                    _________________________________                                          5                    The  government  essentially   agrees  that  appellants          sustained a  loss in their  mortgage loan transaction,  since the          value of the dollar declined, as against the pound sterling, from          the time  of the  mortgage loan  to the  date  of its  repayment.          Nonetheless, says the government, appellants may not offset their          mortgage-loan-transaction   loss   against   their   real-estate-          transaction gain,  because "the  borrowing and  repayment of  the          mortgage loan  is a  separate transaction  from the  purchase and          sale of the personal residence."  Rev. Rul. 90-79, 1990-38 I.R.B.          26 (citing Willard Helburn, 214  F.2d at 818-19; Church's English                     _______________                       ________________          Shoes, Ltd.  v. Commissioner, 24  T.C. 56, 59 (1955),  aff'd, 229          ___________     ____________                           _____          F.2d  957 (2d  Cir. 1956)  (per  curiam)).   Moreover, since  the          mortgage-loan-transaction loss  was not "incurred  in an activity          or as the result of an  event described in section 165(c) of  the          Code[,] . . . [it] may not [be] deduct[ed] . . . ."  Id.                                                               __                    Appellants concede  that the mortgage  loan transaction          was neither carried  out by a trade or  business nor entered into          for  profit,  but  nonetheless  urge  an  integrated  transaction          approach so as to permit their $100,000 mortgage-loan-transaction          loss to  be set off  against the capital  gain realized from  the          sale of  their residence.   Appellants point  out that  though we          employed a separate transactions approach in Willard Helburn, 214                                                       _______________          F.2d at  818, we  recognized that an  integrated approach  to the          transaction   might  have   been   elected   by  the   taxpayer.2                                        ____________________               2Willard  Helburn involved  the  tax  treatment  accorded  a                ________________          purchase of lambskins in New  Zealand for inventory in the United          States, where both the purchase  and the financing were in pounds                                          6          Unfortunately for  appellants, Congress  has since foreclosed  an          integrated  transaction  approach  to  the  exclusively  foreign-          currency financed acquisition involved in the present case.                     Appellants urge, in  effect, that  their mortgage  loan          transaction be considered  part of a "hedging  transaction" under          I.R.C.      988(d)(1),  which  might  result  in  its  integrated          treatment  as part and  parcel of their  real estate transaction.          See  26  U.S.C.     988(d)(1).     "To  the  extent  provided  in          ___          regulations," id., borrowing under a debt instrument in which the                        ___          taxpayer  is obligated  to  repay the  loan  in "a  nonfunctional          currency," id.   988(c)(1), will qualify for treatment as part of                     ___          a "section  988 hedging  transaction" provided  the taxpayer  (i)          entered  into  the  transaction  primarily  "to  reduce  risk  of          currency fluctuations with respect  to property which is held  or          to  be held  by the  taxpayer," id.    988(d)(2)(A)(i),  and (ii)                                          ___                      ___          identified  the transaction as a section 988 hedging transaction.          Id.   988(d)(2)(B).            ___                    Even  assuming  their transaction  qualified,  however,                                        ____________________          sterling.  We  noted that "[t]he  purchases of the  skins in  New          Zealand  and  the  various  financial  arrangements  whereby [the          taxpayer]  ultimately  discharged   in  dollars  its  obligations          arising  out of  such purchases  might  be regarded  as a  single          integrated transaction."  214 F.2d at  818.  But we also went  on          to  note that "[t]he purchases of  the skins in New Zealand might          be viewed separately  and distinct from the  subsequent financial          arrangements .  . .  ."   Id.   Since the  taxpayer rejected  the                                    __          integrated transaction  approach, and the  parties stipulated  to          the  tax  treatment of  the  purchase, we  treated  the financing          separately  from the purchase.   Id. at 819.   Finally, since the                                           __          pound had  dropped in relation  to the dollar, we  concluded that          the taxpayer had realized a taxable gain by settling the mortgage          loan with less costly pounds than the pounds originally borrowed.          Id.          __                                          7          appellants  were ineligible  for "hedging  transaction" treatment          because  it   is  conceded  that   their  mortgage-loan-financing          transaction  was neither  conducted by  a trade  or  business nor          entered into for profit.  See id. 988(e).   The Tax Reform Act of                                    ___ __          1986  provided that  the  section 988  rules,  and thus  "hedging          transaction" treatment under section 988, "would be  inapplicable          to foreign currency gain or  loss recognized by a U.S. individual          residing outside of the United States upon repayment of a foreign          currency  denominated  mortgage  on  the  individual's  principal          residence.  The principles of current law would continue to apply          to such  transaction."  H.R.  Conf. Rep. No. 841,  99th Cong., 2d          Sess. II-669, reprinted in 1986  U.S.C.C.A.N. 4757.  By reason of                        ____________          the  interpretation adopted  by  Congress, moreover,  "[e]xchange          gain or loss is separately accounted for, apart from gain or loss          attributable to  the underlying  transaction" under present  law.          Id. at 4750.  Thus, appellants' claim fails.            __               2.   Capital Gain on Real Estate Sale                2.   Capital Gain on Real Estate Sale                     ________________________________                    The government follows up with the contention that "the          cost and selling price of  the [residence] should be expressed in          American currency  at the rate  of exchange prevailing as  of the          date of  the purchase  and the date  of the  sale, respectively."          Rev. Rul. 54-105, 1954-1 C.B. 12; see Church's English Shoes, 229                                            ___ ______________________          F.2d at 958.3  Appellants  agree that the 453,374 pounds received                                        ____________________               3In   Willard  Helburn,  the  parties  and  the  court,  sub                     ________________                                   ___          silentio, analyzed the purchase and financing of the lambskins as          ________          though the U.S.  dollar were the taxpayer's  functional currency.          The parties  stipulated that the  cost of the lambskins  added to          the taxpayer's inventory was to be translated at the dollar-pound                                          8          for their residence should be translated into U.S. dollars at the          $1.82 exchange rate prevailing at the  date of sale.  They argue,          however, that  the  343,147  pound adjusted  cost  basis  of  the          residence, consisting of the 297,500 pound purchase price and the          45,647 pounds paid  for capital improvements, likewise  should be          expressed in  U.S.  dollar terms  as  of the  date  of the  sale.                                                                      ____          Appellants  correctly state that, viewed "in the foreign currency          in which  it was  transacted," the  purchase generated  a 110,227          pound  gain as  of  the date  of  the sale,  which  translates to          approximately  $200,000 at  the $1.82  per  pound exchange  rate.          Therefore,  they  say,  the  difference between  the  approximate          $300,000  gain  under  the  government's  computation,   and  the          $200,000  gain   appellants  suggest,  approximates   a  $100,000          unrealized foreign exchange  gain on the residence  that resulted          __________          from the increase in  the dollar-pound exchange rate  between the          dates  the residence  was  bought  and sold.    However fair  and          reasonable  their argument  may be,  it amounts  to an  untenable          attempt  to convert  their "functional  currency"  from the  U.S.          dollar to the pound sterling.                      Under  I.R.C.   985(b)(1), use of a functional currency          other than the  U.S. dollar is  restricted to qualified  business          units ("QBU"s).   The functional  currency of a  QBU that  is not          required  to use  the dollar  is  "the currency  of the  economic          environment in which a significant part of such unit's activities                                        ____________________          exchange rate prevailing at the  date of their purchase, 214 F.2d          at 818, and their stipulation was  accepted by the court, id.  at                                                                    __          819.                                          9          are conducted and which is used by such unit in keeping its books          and records."   26 U.S.C.    985(b)(1)(B).   Although  appellants          correctly assert that their residence was purchased "for a pound-          denominated value"  while  they were  "living  and working  in  a          pound-denominated economy," under I.R.C.   989(a) a QBU must be a          "separate and clearly  identified unit of trade or  business of a          taxpayer  which maintains separate books and records."  26 U.S.C.            989(a).   And  since appellants concede  that the  purchase and          sale of  their  residence  was not  carried  out by  a  QBU,  the          district court properly rejected their plea to treat the pound as          their functional currency.            B.   The Sixteenth Amendment Claim          B.   The Sixteenth Amendment Claim               _____________________________                    Appellants  launch  a  double-barreled claim  that  the          income taxation at issue in this case was imposed in violation of          the  Sixteenth Amendment.  The Sixteenth Amendment eliminated any          requirement   that  "income   taxes"  imposed   by  Congress   be          apportioned  among the  states.   See Eisner,  252 U.S.  at 205.4                                            ___ ______          Since Eisner, the Supreme Court has described "`income' . . .  in                ______          its constitutional sense," as "instances of undeniable accessions          to wealth,  clearly realized, and  over which the  taxpayers have          complete dominion."  Commissioner v. Glenshaw Glass Co., 348 U.S.                               ____________    __________________          426, 432 n.11 (1955) (internal  quotation marks omitted), id.  at                                                                    __          431.  Their Sixteenth Amendment claim fails as well.                                         ____________________               4"The Congress shall have power  to lay and collect taxes on          incomes,  from  whatever  source  derived, without  apportionment          among the  several States,  and without regard  to any  census of          enumeration."  U.S. Const. amend. XVI.                                          10               1.   The Mortgage-Loan Transaction Loss               1.   The Mortgage-Loan Transaction Loss                    __________________________________                    With  their   initial  volley,   appellants  implicitly          challenge  the  longstanding  congressional  power  to  determine          allowable  deductions  from  gross income.    Federal  income tax          deductions  are matters  of legislative  grace.  Welch  v. United                                                           _____     ______          States, 750 F.2d 1101, 1106  (1st Cir. 1985) (citing New Colonial          ______                                               ____________          Ice. Co. v. Helvering, 292 U.S. 435, 440, 54 S. Ct. 788,  790, 78          ________    _________          L. Ed.  1348 (1934)).   The nonintegrated tax  treatment Congress          accords  the  acquisition,  sale, and  financing  of  appellants'          residence simply renders nondeductible  the foreign exchange loss          on their foreign-currency denominated mortgage loan.  As  we have          made  clear  in the  past,  Congress possesses  plenary  power to          determine  allowable  deductions  from the  gross  income  it has          elected to  tax.  See State Mut.  Life Assurance Co. of Worcester                            ___ ___________________________________________          v.  Commissioner,  246  F.2d 319,  324  (1st  Cir. 1957)  (citing              ____________          Helvering v.  Independent  Life  Ins.  Co.,  292  U.S.  371,  381          _________     ____________________________          (1934)).                 2.   The Capital Gain on the Residence               2.   The Capital Gain on the Residence                    _________________________________                    Second, appellants  argue  that it  would  violate  the          Sixteenth  Amendment  to  tax,  as  income,  any foreign-exchange          "gain" relating  to  the  sale of  their  residence,  since  they          realized no  "accession to  wealth" as a  result of  the exchange          ________ __          rate disparity which developed  between the purchase and sale  of          their  residence.     Their  argument  attempts  to   revive  the          "functional currency" debate  already discussed.  See  supra pps.                                                            ___  _____          7-9.  As the government points  out, to purchase property with  a                                          11          foreign currency  necessarily places the individual United States          taxpayer  "in a  position to gain  or lose  from a change  in the          exchange rate . .  . ."  Should the foreign  currency increase in          value (as against the dollar) by  the time the property is  sold,          the resulting  gain in U.S.  dollars, the functional  currency of          the  individual  United  States  taxpayer,  plainly  qualifies as          realized income, fully taxable under the Constitution.                                           III                                         III                                      CONCLUSION                                      CONCLUSION                                      __________                    Accordingly, the  district court judgment  is affirmed.          The parties shall bear their own costs.                    SO ORDERED.                    SO ORDERED.                    __________                                          12
