                          T.C. Memo. 2005-283



                        UNITED STATES TAX COURT



                TIMOTHY J. COBURN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6695-04.                Filed December 6, 2005.


     Richard A. Seigal and Mark S. Gregory, for petitioner.

     Michael J. Proto, for respondent.



                          MEMORANDUM OPINION


     WELLS, Judge:   Respondent determined a deficiency in

petitioner’s 2000 Federal income tax of $277,951 and a section

6662 accuracy-related penalty of $55,590.20.      The issue to be

decided is whether petitioner must recognize discharge of

indebtedness income in 2000 with respect to a loan on which

petitioner defaulted.    Unless otherwise indicated, all section
                                - 2 -

references are to the Internal Revenue Code, as amended, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

                             Background

     The parties submitted the instant case fully stipulated,

without trial, pursuant to Rule 122.      The parties’ stipulations

of fact are hereby incorporated by reference and are found as

facts in the instant case.    At the time of filing the petition,

petitioner resided in Glastonbury, Connecticut.

     During 1996, petitioner received stock of PhyMatrix

Corporation (PhyMatrix) and CareMatrix Corporation (CareMatrix)

which had an aggregate value of $1,675,000 at the time of

receipt.1    Petitioner incurred a Federal income tax liability of

$621,980 related to the receipt of the stock.2     Petitioner

borrowed from CareMatrix an amount equal to the Federal income

tax liability (the loan), pledging 57,248 shares of PhyMatrix

common stock (the collateral) as security for the loan.     The loan

and the pledge of the collateral are hereinafter collectively

referred to as the loan transaction.




     1
      The record does not reveal the separate amount or value of
the CareMatrix stock or the value of the PhyMatrix stock at the
time of receipt by petitioner.
     2
      Petitioner appears to have taken an aggregate basis in the
stock of both CareMatrix and PhyMatrix equal to the aggregate
$1,675,000 value of these stocks at the time of receipt.
                                - 3 -

     On April 15, 1997, to complete the loan transaction,

petitioner executed the following three documents:   (1) A

promissory note (the promissory note), (2) a stock pledge

agreement (the stock pledge agreement), and (3) a stock transfer

power (the stock transfer power).   The promissory note, stock

pledge agreement, and stock transfer power are sometimes

hereinafter referred to as the loan documents.   The promissory

note provided that the principal and interest were due and

payable on the earlier of either April 15, 2000, or the date of

the registration of any shares of PhyMatrix stock received by

petitioner pursuant to an agreement dated May 3, 1996.    The

promissory note further provided that petitioner would secure the

liability underlying the promissory note with the collateral.

The stock pledge agreement also provided that petitioner was

required to pledge the collateral as security for the liability

underlying the promissory note and set forth the rights and

duties of petitioner and CareMatrix with respect to the

collateral.   The stock transfer power provided that petitioner

sold, assigned, and transferred the collateral for value

received.    At all relevant times, Abraham D. Gosman (Mr. Gosman)

served as Chief Executive Officer and Chairman of the Board of

CareMatrix and was responsible for the terms of the loan

documents.
                               - 4 -

     As of April 15, 1997, the collateral had an aggregate market

value of approximately $750,000, which represented 120 percent of

the outstanding principal due on the promissory note.3    At the

request of CareMatrix, petitioner delivered the loan documents to

CareMatrix’s counsel.   On or about May 29, 1997, CareMatrix took

possession of the loan documents and the stock certificate for

the collateral from its counsel.

     The promissory note became due and payable on April 15,

2000, at which time the outstanding principal and interest due

was $746,376.52.   CareMatrix subsequently demanded payment, but

petitioner refused to pay, alleging that the promissory note was

nonrecourse and that CareMatrix held the collateral.     CareMatrix

made no further collection efforts.




     3
      The parties stipulated the following with respect to the
value of the collateral as of Apr. 15, 1997: “Pursuant to the
Note, the shares pledged had an aggregate market value of 120% of
the principal borrowed - approximately $750,000.00.” As noted
above, petitioner appears to have taken a basis in the CareMatrix
and PhyMatrix stock equal to the value of the PhyMatrix and
CareMatrix stock at the time the stock was received by petitioner
during 1996. However, the record provides no evidence that the
value of the PhyMatrix stock was the same on April 15, 1997 (the
date of the loan transaction) as it was on the date that the
stock was transferred to petitioner during 1996. Because the
value of the collateral may have fluctuated from the date that
petitioner received the PhyMatrix stock until the date that
petitioner pledged the PhyMatrix stock as collateral, the
aforementioned stipulation as to the value of collateral on
Apr. 15, 1997, is insufficient to establish petitioner’s basis
in the collateral on that date. Consequently, we are unable to
determine from the record petitioner’s basis in the collateral.
                                - 5 -

     On July 14, 2000, PhyMatrix filed a bankruptcy plan of

reorganization, which became effective on September 21, 2000.

The plan provided for the conversion of PhyMatrix stock to shares

of the newly reorganized entity.    However, the plan required that

any PhyMatrix shares be tendered for conversion by March 20,

2001.    The collateral was not timely tendered for conversion.4

     Respondent determined that petitioner’s default on the

promissory note resulted in cancellation of indebtedness income

in the amount of $750,000 and that petitioner should be subject

to an accuracy-related penalty of $55,590.20.

                             Discussion

     Section 61(a)(12) provides that gross income includes income

from discharge of indebtedness, which generally equals the amount

due on the obligation less the amount of any consideration paid

for the discharge.    Babin v. Commissioner, 23 F.3d 1032, 1034

(6th Cir. 1994), affg. T.C. Memo. 1992-673.     Section 61(a)(3)

provides that gross income includes gains derived from dealings

in property.    Section 1001(a) provides that gain from the sale or

other disposition of property is the excess of the amount

realized over the property’s adjusted basis and that loss from

the sale or other disposition of property is the excess of the


     4
      We note that sec. 4 of the Stock Pledge Agreement appears
to require petitioner to tender the collateral for conversion,
pledge shares of the newly reorganized entity as security on the
loan, and deliver such pledged shares to CareMatrix.
                               - 6 -

property’s adjusted basis over the amount realized.    Relying on

Cozzi v. Commissioner, 88 T.C. 435 (1987),5 respondent contends

that petitioner’s default on the loan results in discharge of

indebtedness income to petitioner pursuant to section 61(a)(12).

Petitioner contends that the loan default is treated as a sale or

other disposition of the collateral pursuant to sections 61(a)(3)

and 1001(a), rather than a discharge of indebtedness.

     The facts and circumstances of the instant case demonstrate

that petitioner abandoned the collateral in 2000.6    CareMatrix

took possession of the loan documents and the stock certificate

during the loan transaction.   CareMatrix demanded payment from

petitioner in 2000, but petitioner refused to pay on grounds that


     5
      Respondent also cites Carlins v. Commissioner, T.C. Memo.
1988-79, which relied on our holding in Cozzi v. Commissioner, 88
T.C. 435 (1987).
     6
      We apply a facts and circumstances analysis to determine if
or when an abandonment occurred. Cozzi v. Commissioner, supra at
446. “The proper test is whether, under the facts and
circumstances, it is clear for all practical purposes that the
taxpayer will not retain the property; an overt act of
abandonment by the taxpayer is not necessary.” L&C Springs
Associates v. Commissioner, 188 F.3d 866, 868 (7th Cir. 1999),
affg. T.C. Memo. 1997-469.

     In 2925 Briarpark v. Commissioner, 163 F.3d 313, 318 (5th
Cir. 1999), affg. T.C. Memo. 1997-298, the Court of Appeals for
the Fifth Circuit stated that sec. 61(a)(3) applies if (1) the
debtor is relieved of the obligation to repay the debt and (2)
the debtor is relieved of title to the collateral. However, the
court did not hold that sec. 61(a)(3) cannot apply in absence of
a formal transfer of title. Consequently, the formal passage of
legal title does not necessarily establish the time of
abandonment. L&C Springs Associates v. Commissioner, supra at
870.
                               - 7 -

the loan was nonrecourse and that CareMatrix held the collateral.

CareMatrix took no further action to collect the outstanding

principal and interest on the loan from petitioner.   In an

affidavit stipulated by the parties, Mr. Gosman stated that

petitioner and CareMatrix “intended that, in the event of a

default, repayment would be made only from the collateral and no

other source.”   Consequently, we conclude that petitioner

abandoned the collateral upon his default.   Accordingly, we

consider the Federal income tax consequences of petitioner’s

default on the loan and abandonment of the collateral.

     The parties in the instant case dispute whether the loan is

recourse or nonrecourse.7   The regulations under section 1001

distinguish between a debtor’s disposition of collateral in

satisfaction of an underlying nonrecourse liability and a

debtor’s disposition of collateral in satisfaction of an

underlying recourse liability.8   Specifically, section 1.1001-

2(a), Income Tax Regs.,9 provides that the amount realized on the


     7
      Respondent concedes that the loan constitutes bona fide
indebtedness.
     8
      Such a distinction may affect the character of any gain or
loss on the transaction and the availability of certain
exclusions from gross income. See secs. 1221, 108.
     9
      Sec. 1.1001-2, Income Tax Regs. Discharge of liabilities.--

          (a) Inclusion in amount realized. (1) In general.--
     Except as provided in paragraph (a)(2) and (3) of this
     section, the amount realized from a sale or other
                                                   (continued...)
                               - 8 -

sale or other disposition of property generally includes the

amount of liabilities from which the debtor is discharged but

that the amount realized on the disposition of property securing

a recourse liability does not include discharge of indebtedness

income.   Consequently, a debtor’s transfer, or abandonment, of

property to a creditor in satisfaction of a nonrecourse liability

is treated as a sale or other disposition of the property, and

any resulting income constitutes gain on the disposition of

property rather than discharge of indebtedness income.10   L&C

Springs Associates v. Commissioner, 188 F.3d 866, 868 (7th Cir.

1999), affg. T.C. Memo. 1997-469.   In contrast, a debtor’s

transfer of property to a creditor in satisfaction of a recourse

liability results in gain from the sale or other disposition of

property to the extent that the fair market value of the property



     9
      (...continued)
     disposition of property includes the amount of
     liabilities from which the transferor is discharged as a
     result of the sale or disposition.

          (2) Discharge of indebtedness.--The amount realized
     on a sale or other disposition of property that secures
     a recourse liability does not include amounts that are
     (or would be if realized and recognized) income from the
     discharge of indebtedness under section 61(a)(12). * *
     *
     10
      If the amount of the nonrecourse liability exceeds the
value of the property at the time of the transfer, the debtor
realizes gain to the extent that the liability exceeds the
debtor’s basis in the property at the time of transfer.
Commissioner v. Tufts, 461 U.S. 300, 313 (1983).
                                 - 9 -

exceeds its basis and, to the extent that the liability exceeds

the property’s fair market value, discharge of indebtedness

income is realized.     Frazier v. Commissioner, 111 T.C. 243, 245

(1998); sec. 1.1001-2(c), Income Tax Regs.

     In the instant case, petitioner contends that the loan is

nonrecourse.     As to the recourse nature of the loan, respondent

is not of one mind.    Respondent’s trial memorandum refers to the

liability on the loan as nonrecourse.    Respondent’s opening brief

contends that the Federal income tax result in the instant case

does not depend on whether the loan is recourse or nonrecourse.

Respondent’s reply brief, however, contends that the loan is

recourse.   For the reasons discussed below, we conclude that

petitioner’s abandonment of the collateral did not result in

discharge of indebtedness income to petitioner during

petitioner’s taxable year 2000, regardless of whether the

liability underlying the promissory note is recourse or

nonrecourse.11

     As stated above, a debtor’s abandonment of collateral in

satisfaction of a nonrecourse liability is treated for Federal

income tax purposes as a sale of the collateral pursuant to

section 1001(a).     L&C Springs Associates v. Commissioner, supra

at 868.   Consequently, in the instant case, assuming that the



     11
      Consequently, we need not decide whether the loan is
recourse or nonrecourse.
                              - 10 -

loan is nonrecourse, we conclude that any income realized by

petitioner on the abandonment of the collateral in satisfaction

of the loan is properly treated for Federal income tax purposes

as a gain on the sale or other disposition of the collateral

rather than discharge of indebtedness income.   Id.; see sec.

1.1001-2(a)(1), Income Tax Regs.   Accordingly, we would hold that

petitioner realized no discharge of indebtedness income in 2000

were we to assume that the underlying liability is nonrecourse.

     As noted above, respondent’s trial memorandum and opening

brief contend that the default resulted in discharge of

indebtedness income to petitioner in 2000.   Respondent’s reply

brief surprisingly contends, for the first time, that petitioner

is alternatively liable for gain in the amount of $750,000,

representing an amount realized of $750,000 and a basis of zero.

However, respondent does not offer any evidence to support

respondent’s contention of a zero basis, and the record contains

no such evidence.   Under such circumstances, respondent is

prohibited from raising such an issue for the first time on

brief.   See Smalley v. Commissioner, 116 T.C. 450, 456 (2001).

Petitioner would be prejudiced were we to consider such an issue.

Indeed, we note that respondent objected to petitioner’s motion

for leave to supplement the evidentiary record with evidence of

the value and basis of the collateral, filed after respondent’s

new argument in respondent’s reply brief, which motion we denied.
                                - 11 -

Petitioner obviously was surprised by respondent’s raising of a

new issue on brief that required additional evidence to decide.

     Moreover, we find respondent’s reliance on Cozzi v.

Commissioner, 88 T.C. 435 (1987), to be misplaced.     In Cozzi, the

Commissioner contended that the taxpayers realized discharge of

indebtedness income upon their abandonment of worthless

collateral securing a nonrecourse liability.     The taxpayers in

Cozzi contended that they did not realize discharge of

indebtedness income because they did not abandon the collateral

during the year in issue.12    Id. at 446.   We held that the facts

and circumstances evidenced an abandonment of worthless

collateral by the taxpayers during the year in issue and that

such an abandonment of worthless collateral securing a

nonrecourse liability established a discharge of the underlying

liability.   Id. at 445-448.   Cozzi did not involve a dispute of

whether a debtor’s abandonment of collateral should be treated

for Federal income tax purposes as generating income from a sale

or from a discharge of the underlying nonrecourse liability.

     We now turn to an analysis of the Federal income tax

treatment of the loan default and abandonment of the collateral

based upon the assumption that the loan was recourse.     In

contrast to a nonrecourse liability, a debtor’s abandonment of


     12
      The taxpayers in Cozzi appear to have conceded that
discharge of indebtedness income would result from an abandonment
of the collateral.
                               - 12 -

collateral securing a recourse liability upon the debtor’s

default on the liability, alone, does not extinguish the

underlying liability.   Lockwood v. Commissioner, 94 T.C. 252, 260

(1990).   Unlike collateral securing a nonrecourse liability, the

collateral securing a recourse liability does not represent the

only source of repayment.13   In the instant case, the loan

documents provide CareMatrix with the right to enforce

petitioner’s repayment of the loan, irrespective of whether

petitioner abandoned the collateral to CareMatrix.14


     13
      Black’s Law Dictionary 1086 (7th ed. 1999) provides the
following definitions of a recourse note and a nonrecourse note:

     recourse note. A note that may be satisfied upon
     default by pursuing the debtor’s other assets in
     addition to the collateral securing the note. Cf.
     nonrecourse note.

     nonrecourse note. A note that may be satisfied upon
     default only by means of the collateral securing the
     note, not by the debtor’s other assets. Cf. recourse
     note.
     14
      We recognize, and petitioner does not dispute, that the
terms of the loan documents on their face provide for a recourse
liability. Petitioner instead contends that the loan is
nonrecourse based upon two alternative contentions. The first
contention is that the substance rather than the form of the
transaction should govern and that the underlying facts and
circumstances support the conclusion that the loan is
nonrecourse. Alternatively, petitioner contends that the parties
intended for the loan to be nonrecourse, that the parties made a
mutual mistake in executing a promissory note that did not
accurately reflect their intent, and that the terms of the loan
documents should be reformed to accurately reflect such intent.
Petitioner contends that petitioner “transferred” the collateral
to CareMatrix in satisfaction of a nonrecourse liability, that
the “transfer” of the collateral is properly treated as the sale
                                                   (continued...)
                               - 13 -

Specifically, the promissory note provides that a release of the

collateral by petitioner does not satisfy petitioner’s

obligation.

     [The petitioner’s liability] hereunder * * * shall
     remain unimpaired, notwithstanding * * * the release
     * * * of all or any part of security * * *.

The promissory note also does not waive the right of CareMatrix

to pursue legal remedies upon nonpayment.

     [CareMatrix] shall not, by any act, delay, omission or
     otherwise be deemed to waive any of its rights or
     remedies hereunder unless such waiver be in writing and
     signed by [CareMatrix], and then only to the extent
     expressly set forth therein.

The stock pledge agreement provides that the pledge is to remain

in effect until the loan is paid in full, at which time

CareMatrix is to return the collateral to petitioner.

          Termination of Pledge. This Pledge shall remain
     in effect until all terms and conditions of the Note
     have been satisfied in full and the Indebtedness has
     been paid in full whereupon the Lender shall forthwith
     assign, transfer and deliver to [petitioner] without
     representation, warranty or recourse, against the
     appropriate receipts, all the Pledged Shares, if any,
     then held by it in pledge hereunder.

Additionally, the period of limitations for CareMatrix to

commence an action to enforce petitioner’s repayment does not

expire until April 15, 2006.   See Mass. Gen. Laws ch. 106,




     14
      (...continued)
of the collateral during petitioner’s taxable year 2000, and that
such a sale does not result in discharge of indebtedness income.
                                 - 14 -

§ 3-118 (1998 & Supp. 2005).15    The foregoing demonstrates that

petitioner’s abandonment of the collateral, assuming the loan was

recourse, did not discharge petitioner from the loan during

petitioner’s taxable year 2000.     CareMatrix would have until at

least April 15, 2006, to enforce payment on the loan if it is

recourse.   A taxpayer must recognize income from the discharge of

indebtedness where (1) a liability exists at the time of the

alleged discharge and (2) the taxpayer was in fact discharged

from such liability.   Babin v. Commissioner, 23 F.3d at 1034;

Waterhouse v. Commissioner, T.C. Memo. 1994-467.     In the instant

case, the loan default does not result in discharge of

indebtedness income, assuming the loan was recourse, because

petitioner was never discharged from liability on the loan.

Accordingly, we hold that petitioner realized no discharge of

indebtedness income with respect to the loan for petitioner’s

taxable year 2000.


     15
      In the instant case, the promissory note provides: “This
Note shall be governed by and construed in accordance with the
laws of the Commonwealth of Massachusetts, to the maximum extent
the parties may so lawfully agree.” Similarly, the stock pledge
agreement provides: “This Agreement shall in all respects be
construed and interpreted in accordance with and governed by the
laws of the Commonwealth of Massachusetts.” Consequently, the
laws of Massachusetts govern the interests and rights of the
parties with respect to these documents. See Cook v.
Commissioner, 80 T.C. 512, 520 (1983). Mass. Gen. Laws ch. 106,
sec. 3-118 (2005), provides that an action to enforce payment of
a note must be commenced within 6 years after the due date stated
in the note. As noted above, the promissory note provided for a
due date of Apr. 15, 2000.
                              - 15 -

     On the basis of the foregoing, we hold that petitioner did

not realize discharge of indebtedness income with respect to the

loan default and abandonment of the collateral and that

petitioner is not liable for a section 6662 accuracy-related

penalty.   We have considered all contentions that the parties

have raised.   To the extent not addressed herein, those

contentions are without merit or unnecessary to reach.

     To reflect the foregoing,


                                       Decision will be entered for

                                 petitioner.
