                                                                             F I L E D
                                                                      United States Court of Appeals
                                                                              Tenth Circuit
                      UNITED STATES COURT OF APPEALS
                                                                              MAY 6 1999
                            FOR THE TENTH CIRCUIT
                                                                         PATRICK FISHER
                                                                                   Clerk

MARTIN M. BURKE,

             Petitioner-Appellant,

v.                                                           No. 97-9022
                                                      Appeal from U.S. Tax Court
COMMISSIONER OF INTERNAL                                (T. C. No. 15957-92)
REVENUE,

             Respondent-Appellee.


DATHA D. BURKE,

             Petitioner-Appellant,

v.                                                           No. 97-9023
                                                      Appeal from U.S. Tax Court
COMMISSIONER OF INTERNAL                                (T. C. No. 14139-89)
REVENUE,

             Respondent-Appellee.




                             ORDER AND JUDGMENT*


Before BRORBY, BRISCOE, and LUCERO, Circuit Judges.



*
        This order and judgment is not binding precedent, except under the doctrines of
law of the case, res judicata, and collateral estoppel. The court generally disfavors the
citation of orders and judgments; nevertheless, an order and judgment may be cited under
the terms and conditions of 10th Cir. R. 36.3.
      After examining the briefs and appellate record, this panel has determined

unanimously that oral argument would not materially assist the determination of these

appeals. See Fed. R. App. P. 34(a)(2); 10th Cir. R. 34.1(G). These cases are therefore

ordered submitted without oral argument.

      Petitioners Datha D. Burke and Martin M. Burke, husband and wife, appeal from

the Tax Court’s judgment finding them liable for federal income tax deficiencies for the

year 1982. On appeal, the sole issue is whether Mr. and Mrs. Burke are entitled to relief

from the discharge of indebtedness income pursuant to Bowers v. Kerbaugh-Empire Co.,

271 U.S. 170 (1926). We have jurisdiction to consider this appeal. See 26 U.S.C.

§ 7482(a). For the reasons that follow, we affirm the Tax Court and conclude Mr. and

Mrs. Burke are not entitled to relief from discharge of indebtedness income.

                                            I.

      Mr. and Mrs. Burke each owned fifty percent of the outstanding stock of Burke

Energy Corporation. Burke Energy was the parent company of a consolidated group of

companies engaged in the business of wholesaling and retailing natural gas liquids.




                                           -2-
       Mr. Burke owed Burke Energy approximately $853,000.1 Mr. and Mrs. Burke

sought to remove the receivable from the books of Burke Energy. They engaged in two

transactions to do so. First, Mrs. Burke transferred her interests in two parcels of real

property to Mr. Burke in exchange for shares of stock in Maize State Bank and University

State Bank. Mr. Burke then transferred the real estate to Burke Energy in satisfaction of

the debt.

       The specifics of the two transactions are as follows. On June 20, 1982, Mr. and

Mrs. Burke entered into two contracts to exchange the real property for the bank stock.

One contract stated Mrs. Burke sold the 707 N. Main property for $250,000, payable by


1
       Mr. and Mrs. Burke assert the following facts based upon Mr. Burke’s testimony
before the Tax Court. In 1979 or 1980, Burke Energy acquired a controlling interest in
two banks, Maize State Bank and University State Bank. Burke Energy paid a total of
$853,000 for the controlling interests and listed the bank stock as an asset. Shortly after
Burke Energy acquired the stock, banking regulators for the State of Kansas advised
Burke Energy and Mr. and Mrs. Burke that Kansas law restricted a corporation’s
ownership of bank stock. The regulators directed Burke Energy to divest itself of the
stock. Burke Energy transferred the stock to Mr. Burke and entered in its books a
receivable from Mr. Burke in the amount Burke Energy paid to acquire the controlling
interest in the banks. Also, during the same time, Mr. and Mrs. Burke responded to the
regulator’s mandatory capital calls.

        The Tax Court rejected these facts concluding Mr. Burke’s testimony was not
credible, as it was general, conclusory, and mostly unsupported by other evidence in the
record. “[F]air debates about fact-bound matters of characterization are resolved on
appeal in favor of the solution the trier of fact reaches.” LDL Research & Dev. II, Ltd. v.
Commissioner, 124 F.3d 1338, 1349 (10th Cir. 1997) (quotation omitted). The Tax
Court’s decision to discredit the testimony of Mr. Burke was not clearly erroneous. See
id. at 1344. No evidence, other than Mr. Burke’s testimony, showed that Mr. Burke
purchased the stock from Burke Energy. Rather, other evidence indicates Burke Energy
financed part of Mr. Burke’s purchase of the stock.

                                             -3-
Mr. Burke’s assumption of the $5,294 mortgage and transfer of 29,341 shares of common

stock in Maize State Bank. The second contract, for the A and Walnut property, stated

Mr. Burke would assume a $150,638 mortgage and transfer 20,000 shares of Maize State

Bank common stock and 23,534 shares of University State Bank common stock in

exchange for the property, which they valued at $675,000. The stocks were transferred at

Mr. Burke’s acquisition price.

       At the time of the transaction, both Mr. and Mrs. Burke were co-obligors on the

mortgages. Her basis in the 707 N. Main property was $8,850, and her basis in the A and

Walnut property was $72,426. Although the 707 N. Main property was worth $250,000,

the A and Walnut property actually was worth only $262,000. The shares of Maize State

Bank common stock and University State Bank common stock were worth $8.34 and

$1.89 respectively.

       Despite the contracts, Mr. Burke did not transfer any of the stock to Mrs. Burke.

It had been pledged as collateral for various obligations. Even after the transfer of the

real estate, Mrs. Burke continued to remain an obligor on the mortgages.

       After Mrs. Burke transferred the real estate to Mr. Burke, he in turn transferred it

to Burke Energy to satisfy his indebtedness to the corporation. Specifically, on June 29,

1982, nine days after the contracts between Mr. and Mrs. Burke had been formalized,

Mr. Burke and Burke Energy entered into two contracts, one for each parcel of realty.

The contract regarding the 707 N. Main property stated Burke Energy was purchasing


                                            -4-
the property for $250,000 by assuming a $5,294 mortgage on the property and by

canceling $244,706 of Mr. Burke’s outstanding debt. The contract regarding the A and

Walnut property set forth a $675,000 purchase price with Burke Energy assuming a

$150,638 mortgage and canceling the remaining $524,362 portion of Mr. Burke’s

indebtedness. Even after the property had been deeded to Burke Energy, Mr. and Mrs.

Burke remained liable on the mortgages.

      On their 1982 joint income tax return, Mr. and Mrs. Burke reported a short term

capital gain of $16,690 from the transfer of the properties by Mr. Burke to Burke Energy.

In computing the gain, Mr. and Mrs. Burke used a selling price of $853,086 and a basis

of $836,396.2 They did not report any gain or loss on the transaction between

themselves. Nor did they report any income from Burke Energy’s cancellation of Mr.

Burke’s indebtedness in an amount greater than the value of the properties he transferred.



      In 1984, Mr. and Mrs. Burke claimed a long term capital loss of $1,059,900 with

respect to the University State Bank common stock. The loss was carried forward. The

record does not indicate whether the Burkes have ever claimed a loss with respect to the

Maize State Bank common stock.




2
       The basis amount was not Mrs. Burke’s basis in the real property. Presumably, it
was the value of the consideration Mr. Burke provided to Mrs. Burke in exchange for the
real property.

                                           -5-
       Upon audit, the Commissioner determined the A and Walnut property was worth

only $262,000, not $675,000. The Commissioner also determined Mr. and Mrs. Burke

received a dividend of $413,000 from Burke Energy and a capital gain of $430,724 from

Burke Energy’s discharge of Mr. Burke’s indebtedness. Accordingly, the Commissioner

issued separate notices of deficiency to Mr. and Mrs. Burke.

       Mr. and Mrs. Burke filed separate petitions for review in the Tax Court, arguing

they were entitled to relief from the deficiency assessments under the judicially-created

exception to discharge of indebtedness income set forth in Kerbaugh-Empire, 271 U.S.

170. The Tax Court consolidated their cases. The Tax Court agreed with the

Commissioner that Mr. and Mrs. Burke received $431,000 in capital gains and $413,000

in dividend income from cancellation of the indebtedness in 1982. The court stated it

was unpersuaded that Kerbaugh-Empire created an exception to the discharge of

indebtedness income under the circumstances of this case. Rather, the Tax Court found

Mr. and Mrs. Burke had overvalued the A and Walnut property when they transferred it

to Burke Energy and were seeking to mitigate the tax burden flowing from

overvaluation. Mr. and Mrs. Burke appealed.

                                            II.

       “We review the Tax Court’s factual findings under the clearly erroneous standard

and purely legal questions de novo.” LDL Research & Dev. II, Ltd. v. Commissioner,

124 F.3d 1338, 1342 (10th Cir. 1997). Whether several acts are separate transactions or


                                            -6-
“are integrated steps in a single transaction is a question of fact.” Estate of Kluener v.

Commissioner, 154 F.3d 630, 634 (6th Cir. 1998). Whether Mr. and Mrs. Burke have

income from the discharge of indebtedness is a question of law. See Vukasovich, Inc. v.

Commissioner, 790 F.2d 1409, 1411 (9th Cir. 1986).

                                             III.

       The issue before this court is whether Mr. and Mrs. Burke have income from the

discharge of indebtedness. Mr. and Mrs. Burke agree that taxpayers generally realize

income upon the discharge of indebtedness. See I.R.C. § 61(a)(12). They further agree

that they do not qualify for any statutory exceptions to discharge of indebtedness income.

See I.R.C. § 108(a)(1). Rather, Mr. and Mrs. Burke continue to argue Kerbaugh-Empire,

271 U.S. 170, provides them with a judicially-created exception to discharge of

indebtedness income.3 They believe all transactions should be collapsed into a single

transaction and there should be no recognized income from the discharge of indebtedness

because they ultimately realized a loss on the bank stock. Mr. and Mrs. Burke contend

Mr. Burke incurred debt to purchase the bank stocks, but the investment proved to be a

loss when viewed along with the income from the discharge of indebtedness. They

maintain that, under the circumstances of an overall loss, the substance of the transaction




3
      Mr. and Mrs. Burke do not contest the Tax Court’s computations or its
determination of the fair market value of the A and Walnut property.


                                             -7-
should govern over its form. They concede, however, that if form governs, the

Commissioner prevails.

       Before considering the tax consequences of the overall transaction, we must first

consider the appropriate characterization of the transfer of the real property from Mrs.

Burke to Mr. Burke. Mr. and Mrs. Burke argue the transfer of real estate from Mrs.

Burke to Mr. Burke was a gift because she did not receive any consideration for the

transfer of the property since Mr. Burke was already liable for the mortgage and the stock

could not be transferred. They thus maintain the transaction should be viewed as a

contribution to capital of the real estate by Mrs. Burke coupled with discharge of

indebtedness income to Mr. Burke, which need not be reported as income due to the

overall loss.

       Mr. and Mrs. Burke, however, did not describe or set up the transfer of the real

property from Mrs. Burke to Mr. Burke as a gift. They specifically referred to each

transfer as a sale. See generally Commissioner v. National Alfalfa Dehydrating &

Milling Co., 417 U.S. 134, 149 (1974) (“[W]hile a taxpayer is free to organize his affairs

as he chooses, nevertheless, once having done so, he must accept the tax consequences of

his choice, whether contemplated or not . . . .”); McCoy Enters., Inc. v. Commissioner,

58 F.3d 557, 561 (10th Cir. 1995) (“It is well settled that taxpayers are generally held to

the consequences of their own characterizations of transactions.”). Also, in the exhibits

attached to their Tax Court petitions, they explicitly stated the two steps should not be


                                            -8-
ignored and the contracts should be followed as written. See No. 97-9022 R. Doc. 1, Ex.

J at 10; No. 97-9023 R. Doc. 1, Ex. K at 10.

       The Commissioner argues it is irrelevant whether the property was transferred as

part of a bona fide sale or as a gift, because Mrs. Burke’s basis would be the appropriate

basis for computing capital gain under either scenario. If Mrs. Burke gifted the real

property to Mr. Burke, he would have acquired her basis in the property. See I.R.C.

§§ 1015(a), (e); 1041(b). Under such a scenario, any income would have been computed

based on the acquired basis at the time Mr. Burke transferred the property to Burke

Energy. If Mrs. Burke sold Mr. Burke the property, the transfers would be a taxable

disposition under I.R.C. § 1001(a), requiring a gain to be reported. We agree with the

Commissioner that Mrs. Burke’s basis must be used for computing gain, regardless of

how the transfers between Mr. and Mrs. Burke are characterized.

       Having determined characterization makes no difference for tax purposes, we now

decide whether Kerbaugh-Empire provides an exception for the discharge of

indebtedness income. We note initially that Kerbaugh-Empire has been implicitly

repudiated by the Supreme Court in subsequent decisions. See Preslar v. Commissioner,

167 F.3d 1323, 1332 (10th Cir. 1999) (citing Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 429-32 & n.11 (1955); United States v. Kirby Lumber Co., 284 U.S. 1, 2

(1931)). In any event, Kerbaugh-Empire is of no help to the Burkes here. Kerbaugh-

Empire involved a corporation that (1) borrowed German marks from 1911 to 1913 to


                                            -9-
finance construction contracts being performed by a subsidiary, (2) lost money on the

underlying transaction from 1913 to 1918, and (3) repaid the loan in 1921 with marks

that had depreciated in value. See Kerbaugh-Empire, 271 U.S. at 172-73. The Supreme

Court held the difference between the purchase price of the marks and the repayment

amount was not income in 1921, the tax year at issue; rather, it was a reduction of the

loss on the underlying transaction and was therefore not taxable. See id. at 175. In

reaching its decision, the Court gave controlling weight to the substance rather than the

form of the transaction. See id. at 174.

       Like the taxpayer in Kerbaugh-Empire, Mr. and Mrs. Burke also lost money on

the overall transaction. The Commissioner, however, contends they must be able to

show the loss took place before the end of the tax year in question, 1982, in order for

Kerbaugh-Empire to apply. We agree.

       In Kerbaugh-Empire, the Supreme Court made its decision based on a tax year

when all income and losses had been finally determined. Here, there was no final

outcome in 1982, the tax year at issue. There is no indication the bank stock became

worthless or declined in value in 1982. The Tax Court found the Maize State Bank

common stock had a basis of $5.92 per share and a value in June of 1982 of $8.34 per

share. The Tax Court found the University State Bank common stock had a fair market

value of $1.89 per share in June of 1982. Mr. and Mrs. Burke do not dispute these

findings with citation to evidence to the contrary. Indeed, at the time they filed their Tax


                                            -10-
Court petitions, Mr. and Mrs. Burke indicated the stocks provided valuable consideration

to Mrs. Burke in exchange for the property. See No. 97-9022 R. Doc. 1, Ex. J at 10;

No. 97-9023 R. Doc. 1, Ex. K at 10. Also, on their 1982 joint tax return, Mr. and Mrs.

Burke stated Mr. Burke’s basis in the real property following the stock transaction with

Burke Energy was $836,396. See No. 97-9022, Ex. 1-A, Schedule D. Assuming the

mortgage accounted for $156,032 of this $836,396 basis, $680,364 of the basis related to

the stock. Thus, there is no evidence of a loss with respect to the stock in 1982. Further,

Mr. and Mrs. Burke claimed a loss on the University State Bank common stock on their

1984 tax return. They presented no evidence that the Maize State Bank common stock

ever resulted in a loss.

       To except Mr. and Mrs. Burke from discharge of indebtedness income in 1982

would allow them to take a deduction for the same loss in both 1982 and 1984. It is not

reasonable to expect the Commissioner to recalculate taxes for prior years every year

there is an accounting event which may cause a possible impact. See Healy v.

Commissioner, 345 U.S. 278, 284-85 (1953) (“It would be disruptive of an orderly

collection of the revenue to rule that the accounting must be done over again to reflect

events occurring after the year for which the accounting is made, and would violate the

spirit of the annual accounting system. This basic principle cannot be changed simply

because it is of advantage to the taxpayer . . . in a particular case that a different rule be

followed.”); see also Waynesboro Knitting Co. v. Commissioner, 225 F.2d 477, 479-80


                                              -11-
(3d Cir. 1955) (recognizing that rule of Kerbaugh-Empire that diminution of loss is not

gain does not apply merely because end result of transactions extending over period of

years turns out to be loss; relying on Burnet v. Sanford & Brooks Co., 282 U.S. 359,

364-65 (1931), which recognizes annual accounting for tax purposes). Thus, Kerbaugh-

Empire does not extend to the factual circumstances present here.

       We conclude Mr. and Mrs. Burke had taxable income from the discharge of

indebtedness in 1982. Accordingly, we affirm the Tax Court’s ruling that Mr. and

Mrs. Burke are liable for the tax deficiency.

       The judgment of the United States Tax Court is AFFIRMED.



                                                       Entered for the Court



                                                       Mary Beck Briscoe
                                                       Circuit Judge




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