                       T.C. Memo. 1998-135



                     UNITED STATES TAX COURT



              CITY OF COLUMBUS, OHIO, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3301-95B.                      Filed April 6, 1998.



     David L. Miller and David A. Rogers, for petitioner.

     Marsha A. Sabin, Sunita B. Lough, and Joel E. Helke, for

respondent.



                 SUPPLEMENTAL MEMORANDUM OPINION


     TANNENWALD, Judge:     This case is before the Court on remand

from the Court of Appeals for the District of Columbia Circuit in

City of Columbus v. Commissioner, 112 F.3d 1201 (D.C. Cir. 1997),

vacating and remanding 106 T.C. 325 (1996).    The issue for

decision is whether the prepayment by petitioner of its
                                 - 2 -

indebtedness constitutes investment-type property under section

148(b)(2)(D).1

     The findings of facts are set forth in our previous opinion,

City of Columbus v. Commissioner, 106 T.C. 325 (1996), and are

incorporated herein by this reference.     We repeat only those

facts necessary to an understanding of the instant issue.

     In 1965, the State of Ohio created a fully funded statewide

pension fund for police officers and firefighters (the State

fund) to replace the unfunded plans maintained by petitioner and

other Ohio municipalities.     The State fund assumed and guaranteed

the pre-1967 pension liabilities of such municipalities,

including petitioner (the State fund obligation).     State law

required each municipality to transfer its pension liabilities

and assets to the State fund and to pay the State fund, either

immediately or over time with interest, an amount equal to its

accrued unfunded pension liability.      Petitioner transferred its

pension liabilities and assets on January 1, 1967, and chose to

pay its accrued unfunded pension liability over time (the city

obligation).     Petitioner made scheduled payments until November

1993, when it entered into a prepayment agreement with the State

fund whereby petitioner paid the balance remaining on the city

obligation (the remaining obligation) in a lump-sum equal to 65


     1
        Unless otherwise indicated, all statutory references are
to the Internal Revenue Code, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 3 -

percent of the outstanding principal balance (plus interest from

the time of the prepayment agreement until date of the lump-sum

payment).   Petitioner made the lump-sum payment on January 31,

1994 (the prepayment).

     Petitioner proposed to issue tax-exempt bonds to finance the

lump-sum payment and requested a ruling from respondent that the

interest on the proposed bonds would be exempt under section 103.

Respondent denied petitioner's request on the ground that such

bonds would be arbitrage bonds pursuant to section 148.    In our

original opinion, we attributed the prepayment to the acquisition

of the State fund obligation in 1967, City of Columbus v.

Commissioner, 106 T.C. at 334, and concluded that the bonds would

be arbitrage bonds.   The Court of Appeals reasoned that, if we

were correct in that attribution, the proposed bonds could not be

arbitrage bonds because the arbitrage provisions did not apply

retroactively to the 1967 transaction.     City of Columbus v.

Commissioner, 112 F.3d at 1205-1206.     The Court of Appeals

remanded the case and defined the scope of the remand as follows:

     The purpose of § 148 is to prevent states and local
     governments from using tax-exempt bond proceeds to
     acquire higher yielding "investment property." Even if
     a "prepayment for property" may itself be investment
     property, it remains to be seen whether the City of
     Columbus, by satisfying its obligation to the State
     Fund in 1994, was making a "prepayment for property."
     Before the anti-abuse regulations [sec. 1.148-10(e),
     Income Tax Regs.] is considered, that question must be
     resolved. [Id. at 1207.]
                                - 4 -

     It is clear that the threshold question is a narrow one:

Does the acquisition of one's indebtedness constitute an

acquisition of property so as to bring section 148 into play?2

     It is petitioner's position that the prepayment extinguished

its indebtedness to the State fund and that it acquired no

property in that transaction.   It is respondent's position that

petitioner's prepayment was investment-type property.   Respondent

describes the result of petitioner's prepayment as "the city

received economic property through this investment use."

Respondent argues that to allow petitioner to issue tax-exempt

bonds contravenes the intent of section 148 through the use of a

vehicle similar to that of the prepayment for property or

services described in section 1.148-1(b), Income Tax Regs.

     The purpose of section 148 is to prevent the use of tax-

exempt bonds to acquire higher-yielding investment property.

City of Columbus v. Commissioner, 112 F.3d at 1207; Conf. Rept.

99-841 (1986), 1986-3 C.B. (Vol. 4) 1, 747 ("the arbitrage

restrictions are expanded to apply to the acquisition of any

property held for investment other than another bond exempt from

tax under Code section 103."); sec. 1.148-10(a), Income Tax Regs.

Section 148(b)(2) defines investment property to include any

security, any obligation, any annuity contract, and any

     2
        We left this question aside in our original opinion, and
the Court of Appeals did likewise. City of Columbus v.
Commissioner, 106 T.C. 325, 334 (1996), revd. and remanded 112
F.3d 1201, 1205 (D.C. Cir. 1997).
                               - 5 -

investment-type property.   It is the scope of "investment-type

property" that is at issue herein.     Section 1.148-1(b), Income

Tax Regs. states:

     Investment-type property includes any property, other
     than property described in section 148(b)(2)(A), (B),
     (C), or (E), that is held principally as a passive
     vehicle for the production of income. Except as
     otherwise provided, a prepayment for property or
     services is investment-type property if a principal
     purpose for prepaying is to receive an investment
     return from the time the prepayment is made until the
     time payment otherwise would be made. * * *

     Unquestionably, petitioner, by prepaying the remaining city

obligation, extinguished its preexisting debt. While petitioner

received an economic benefit from prepaying its debt, we do not

think it was paying for property.    Petitioner purchased or

received nothing, beyond the State fund obligation it received

under the 1967 transaction, other than the discount for prepaying

its obligation to the State.   Such discounts normally are

considered discharge of indebtedness income, not investments.

Sec. 61(a)(12); United States v. Kirby Lumber Co., 284 U.S. 1

(1931); Consolidated Edison Co. of New York, Inc. v. United

States, 10 F.3d 68 (2d Cir. 1993); Michaels v. Commissioner, 87

T.C. 1412, 1417 (1986) ("the discount here at issue was realized

by the prepayment, which is not considered a sale or exchange").

In cases where a purchase-money debt is owed to the seller, the

reduction generally is treated as a purchase price adjustment.

Sec. 108(e)(5); House v. Commissioner, T.C. Memo. 1995-92.
                                 - 6 -

     Respondent seeks comfort from Consolidated Edison Co. of New

York, Inc. v. United States, supra.      In that case, the taxpayer

prepaid real property taxes to New York City and received a

discount.   It contended that the discount was tax-exempt

interest.   The Court of Appeals for the Second Circuit rejected

that contention and held that the discount was includable in

gross income.   The Court of Appeals then went on to hold that,

under the particular circumstances involved, the taxpayer was

entitled to deduct the full amount of the accrued taxes,

unreduced by the discount, on the ground that it utilized the

economic value of the discount to make the payments.     There is

not the slightest indication by the Court of Appeals that it

considered the economic value of the discount as constituting

property, which is the issue involved herein.     Such being the

case, and given the totally different circumstances involved

herein, we find respondent's reliance on Consolidated Edison Co

of New York, Inc.   misplaced.

     The long and short of the matter is that the discount

involved herein had economic value but that value cannot be

equated with property for which petitioner made the prepayment.

Consequently, we answer in the negative the threshold question

delineated by the remand.

      Since there is no prepayment for property, we hold that the

prepayment in and of itself does not constitute investment-type
                               - 7 -

property.3   Such being the case, petitioner's bonds are not

arbitrage bonds.   Cf. California Health Facilities Authority v.

Commissioner, 90 T.C. 832, 843 (1988) (lending of bond proceeds

is not an "investment" with the result that such use does not

give rise to arbitrage).

                                            Decision will be entered

                                       for petitioner.




     3
        As the Court of Appeals for the District of Columbia
Circuit stated in City of Columbus v. Commissioner, 112 F.3d at
1205:

     We also have no doubt that the 1994 transaction was a
     "prepayment." But was the city's prepayment "for property"?
     Only if it was may the prepayment itself be treated as
     "investment-type property" under the regulation. * * *
