                            T.C. Summary Opinion 2016-74



                           UNITED STATES TAX COURT



             KARL D. BOBO AND KIMBERLY D. BOBO, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 15840-15S.                           Filed November 8, 2016.



      Karl D. Bobo and Kimberly D. Bobo, pro sese.

      Annie Lee, Thomas R. Mackinson, and Michael Skeen, for respondent.



                                SUMMARY OPINION


      PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in effect when the

petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not


      1
          Unless otherwise indicated, subsequent section references are to the
                                                                        (continued...)
                                          2

reviewable by any other court, and this opinion shall not be treated as precedent

for any other case.

      In a notice of deficiency dated March 23, 2015, respondent determined a

deficiency of $7,175 in petitioners’ Federal income tax for 2012. The issue for

decision is whether petitioners’ receipt in 2012 of $20,500 designated by the payor

as payment for a deed in lieu of foreclosure is ordinary income. Respondent also

determined that petitioners are liable for an alternative minimum tax of $410. This

is a computational adjustment dependent on the outcome of the disputed issue.

                                    Background

      Some of the facts have been stipulated, and we incorporate the stipulation of

facts by this reference. Petitioners resided in California when the petition was

timely filed.

      Petitioners Karl D. Bobo (petitioner husband) and Kimberly D. Bobo were

residing in California during the year in issue. In 2008 petitioners owned their

primary residence in California (California house) but worked in management

positions requiring frequent travel to North Carolina. For this reason petitioners

purchased a second house in North Carolina (North Carolina house) in March

      1
       (...continued)
Internal Revenue Code in effect for the year in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
                                          3

20082 for $850,000. Petitioners secured a nonrecourse mortgage note to finance

90% of the purchase price and made a downpayment of $85,000.

      Sometime before May 2012 petitioners began experiencing financial

difficulties and sought loan modifications from the companies holding mortgages

on the California and North Carolina houses. Although petitioners did not qualify

for a loan modification for the loan on the North Carolina house, the mortgage

company Green Tree Services, LLC (Green Tree), informed petitioners that they

might qualify for a “deed in lieu of foreclosure” (deed in lieu of foreclosure)

program. Since petitioners could no longer afford to make payments on the North

Carolina mortgage loan, they applied for and were accepted into this program.

      In May 2012 petitioners entered into a deed in lieu of foreclosure agreement

with Green Tree that included a “cash for keys” (cash for keys) payment. Under

the terms of this agreement petitioners signed the deed over to Green Tree and in

exchange the mortgage company forgave the balance of petitioners’ note on the

property. Petitioners also agreed to vacate the property by a certain time and meet

other specified requirements, including leaving the property in “broom-swept

condition”, and in exchange petitioners would receive a cash for keys payment.

      2
       Petitioners’ tax return reported the purchase date of March 26, 2008.
Petitioners executed the promissory note relating to the purchase of the house on
January 23, 2008.
                                          4

      The cash for keys program was designed by mortgage lenders to allow them

to gain possession of a property quickly and avoid a long foreclosure process.

Lenders began issuing these payments in exchange for borrowers’ vacating a

property quickly and leaving it in good condition. A foreclosure process to

reclaim a property can be time consuming, causing a lender to spend time and

money and risk further damage to the property.3

      Petitioners provided a copy of the letter from Green Tree’s law firm

Hutchens, Senter, Kellam, & Petit, P.A. dated May 4, 2012. The letter stated that

“you have agreed to sign a deed in lieu of foreclosure on your property” in North

Carolina. The letter instructed petitioners as follows:

      Please sign the enclosed Deed, Marital Status Affidavit(s), Affidavit
      Regarding Liens, and Estoppel Affidavit before a Notary Public and
      return these documents to our office no later than 5/25/2012 and
      vacate by 5/25/2012. A property inspection will be ordered by Green
      Tree on or after 5/25/2012. Based on your agreement with the lender
      $20,500.00 cash for keys incentive will be issued by Green Tree once
      Green Tree confirms property is vacant and in broom swept
      condition.

      Also please send evidence/information that assessments and
      homeowners association dues if any are paid in full to the transfer
      date unless other agreements regarding these items have been
      previously approved by the lender, and forward all keys to the subject


      3
       Respondent provided this explanation at trial, and petitioners did not
dispute the nature of the cash for keys program.
                                      5

      property, if you have any in your possession, to our office when you
      return the documents mentioned above.

      Petitioners also provided copies of the marital status affidavit, warranty

deed, affidavit regarding liens, and estoppel affidavit, all dated May 21, 2012,

executed as part of the agreement described in the letter dated May 4, 2012. The

warranty deed and the estoppel affidavit reflect that petitioners signed the deed to

the North Carolina house and agreed to vacate it by May 25, 2012, in exchange for

Green Tree’s canceling the note on the North Carolina house.

      Green Tree issued a Form 1099-MISC, Miscellaneous Income, for the cash

for keys payment in petitioner husband’s name and categorized the $20,500 in box

7 as “nonemployee compensation”.4 Green Tree also issued a Form 1099-A,

Acquisition or Abandonment of Secured Property, to petitioner husband. The

Form 1099-A reported an acquisition date of May 29, 2012, a loan principal

balance outstanding of $716,426, and fair market value of the property of

$607,500.5



      4
      Petitioner husband did not work for Green Tree. The parties agree that
Green Tree issued the Form 1099-MISC for the cash for keys incentive payment.
      5
       Green Tree calculated the cancellation of debt income of $108,926 as
follows:

                                                                       (continued...)
                                           6

      Petitioners timely filed a joint Form 1040, U.S. Individual Income Tax

Return, for 2012 on July 11, 2013.6 Harry Bergland, Jr., a certified public

accountant, prepared the 2012 Federal income tax return. Petitioners attached to

their Form 1040 a Form 8949, Sales and Other Dispositions of Capital Assets,

relating to disposition of the North Carolina house. On Form 8949 petitioners

claimed a cost basis of $850,000 in the North Carolina house and gross proceeds

of $736,926 from the deed in lieu of foreclosure transaction with Green Tree,

resulting in a loss of $113,074.7




      5
          (...continued)
                               Cancellation of debt income
                Loan principal balance outstanding      $716,426
                Fair market value of property           (607,500)
                Total income                             108,926


      6
     Petitioners attached to their Form 1040 a Form 4868, Application for
Automatic Extension of Time to File U.S. Individual Income Tax Return.
      7
       Mr. Bergland calculated petitioners’ gross proceeds by adding the cash for
keys incentive payment to the fair market value of the North Carolina house and
the cancellation of debt income.
                                                                     (continued...)
                                             7

      Respondent issued a notice of deficiency dated March 23, 2015,

reclassifying the $20,500 payment from Green Tree as ordinary income.

Petitioners timely filed their petition on June 18, 2015, contesting the notice of

deficiency and asserting “the return is correct as originally filed”.

                                      Discussion

I.    Burden of Proof

      In general, the Commissioner’s determination set forth in a notice of

deficiency is presumed correct, and the taxpayer bears the burden of proving that

the determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). Pursuant to section 7491(a), the burden of proof as to factual matters

shifts to the Commissioner under certain circumstances. Petitioners did not allege

or otherwise show that section 7491(a) applies. See sec. 7491(a)(2)(A) and (B).

Therefore, petitioners bear the burden of proof. See Rule 142(a).

      7
          (...continued)
             Calculation of gross proceeds              Calculation of loss
       Cash for keys payment         $20,500     Gross Proceeds      $736,926
       Fair market value             607,500     Cost basis          (850,000)
       Cancellation of debt                      Loss                 113,074
        income                       108,926
       Total proceeds                736,926
                                          8

II.   Deed in Lieu of Foreclosure and Cash for Keys Payment

      Section 61(a) defines gross income as “all income from whatever source

derived” and includes compensation paid for services, whether furnished by the

taxpayer as an employee or as a self-employed person or independent contractor.

Gains derived from the sale or exchange of property are included in gross income

unless excluded by law. Sec. 1.61-6(a), Income Tax Regs. The specific rules for

computing gain or loss on the sale of property are governed by section 1001. Id.

      It is “well settled” that the transfer of property by deed in lieu of foreclosure

constitutes a “sale or exchange” for Federal income tax purposes. Allan v.

Commissioner, 86 T.C. 655, 659 (1986), aff’d, 856 F.2d 1169 (8th Cir. 1988);

Freeland v. Commissioner, 74 T.C. 970, 979 (1980); Lowry v. Commissioner, T.C.

Memo. 2003-225, aff’d, 171 F. App’x 6 (9th Cir. 2006). The gain or loss

recognized on this “sale or exchange” is the difference between the amount

realized from the disposition and the property owner’s adjusted basis. Sec.

1001(a). The amount realized from the disposition is the sum of any money

received in the transfer plus the fair market value of property (other than money)

received. Sec. 1001(b). When a taxpayer’s obligation to repay a nonrecourse

mortgage is extinguished, he includes the amount of the extinguished debt in his

amount realized under section 1001(b). Allan v. Commissioner, 86 T.C. at 661;
                                          9

sec. 1.1001-2(a)(1), Income Tax Regs.; see also Commissioner v. Tufts, 461 U.S.

300, 317 (1983); Crane v. Commissioner, 331 U.S. 1 (1947). The taxpayer’s

adjusted basis is generally a cost basis. Sec. 1012(a).

      The Court looks to the substance of the transaction when determining how a

deed in lieu of transaction or a similar exchange is taxed. 2925 Briarpark, Ltd. v.

Commissioner, T.C. Memo. 1997-298, 1997 WL 357880, at *4, aff’d, 163 F.3d

313 (5th Cir. 1999). In 2925 Briarpark, Ltd. v. Commissioner, 1997 WL 357880,

at *1, a partnership secured a loan to purchase a parcel of land and finance

construction of a building. The partnership converted the loan to a nonrecourse

loan and later defaulted on the loan. Id., 1997 WL 357880, at *1-*2. After

defaulting, the partnership found a third party willing to purchase the property

upon the satisfaction or removal of its encumbrances, which included a lien by the

bank holding the taxpayer’s loan. Id. at *2. The bank agreed to release the

partnership from the lien and the nonrecourse loans if the partnership met the

following conditions: (1) sale of the property to the third party for a minimum sale

price of $11.6 million; (2) assignment of the sale proceeds to the bank; (3) transfer

of the partnership’s cash reserves of $177,495 to the bank; and (4) a $175,000

payment by the partnership’s general partner. Id. The partnership met all of the

bank’s conditions by selling the property, assigning the sale proceeds to the bank,
                                          10

and transferring the cash from the partnership and the general partner. Id. The

bank subsequently released the property from the lien and nonrecourse loan,

resulting in cancellation of $14 million of indebtedness. Id. at *2-*3.

      The Court held that the “the sale of the property, the transfer of $177,495

cash, and the assignment of the sale proceeds * * * has the same practical effect as

several other transactions which have been held to be a ‘sale or exchange.’” Id. at

*4. The transaction is the “functional equivalent of a foreclosure, reconveyance in

lieu of foreclosure, abandonment, or repossession” and “[a]ny differences * * * are

not in substance, but in form.” Id. The Court did not treat the cash sale and the

discharge of the loan as two independent events because “[t]he record before us

* * * is replete with evidence” that the sale and the discharge were the result of a

single transaction, the sale of the property. Id. at *5.

      On the basis of this record we are satisfied that the deed in lieu of

foreclosure and the cash for keys incentive are the results of a single transaction.

Similar to the partnership in 2925 Briarpark, Ltd., which had multiple agreements

relating to the exchange of the property, petitioners had two agreements with

Green Tree stemming from the exchange of property: the deed in lieu of

foreclosure agreement and the cash for keys agreement. Looking at the substance

of the transaction the two agreements are inseparable; Green Tree would not have
                                            11

issued the cash for keys payment but for petitioners’ agreeing to sign over the deed

to the property. Thus the cash for keys payment should be treated as part of the

deed in lieu of foreclosure transaction and included in the amount realized on the

North Carolina house. See sec. 1001(b) (amount realized includes money

received); 2925 Briarpark, Ltd. v. Commissioner, 1997 WL 357880, at *4-*5.8

      As a result, we calculate the gross proceeds from the transaction by adding

the cash for keys incentive payment to the amount of loan forgiveness.

Petitioners’ basis in the property is their cost basis.9 See secs. 1001(a) and (b),

1012(a); sec. 1.1001-2(a)(1), Income Tax Regs.

      Respondent argues that the $20,500 cash for keys payment is an incentive

payment which petitioners received only by fulfilling the conditions of the cash for

      8
        The Court recognizes that 2925 Briarpark, Ltd. relates to the inclusion of
proceeds from extinguishment of debt in the amount realized on the “sale or
exchange” of a property and treatment of multiple agreements as part of a single
property sale or exchange transaction. We extend these general principles to apply
to the situation in which the lender made a cash for keys payment to petitioners in
addition to cancellation of indebtedness.
      9
          This achieves the same result as petitioners’ calculation on their return.
             Calculation of proceeds                       Calculation of loss
Cash for keys payment             $20,500         Gross proceeds             $736,926
Balance of loan forgiven          716,426          Cost basis                (850,000)
Total proceeds                    736,926          Loss                       113,074
                                        12

keys program. Respondent asserts that this incentive payment is not part of the

amount realized in the exchange and should instead be considered ordinary

income. It is clear from the record that Green Tree did not hire petitioner husband

for services or have another reason to issue the cash for keys payment. See sec.

61(a); sec. 1.61-6(a), Income Tax Regs. Rather, the cash for keys payment was

part of a single transaction, the property sale or exchange; Green Tree paid

petitioners $20,500 to avoid the lengthy and expensive legal process of foreclosure

as part of the deed in lieu of foreclosure process. The two agreements are

inextricably linked, and there is no basis for treating them separately. See 2925

Briarpark, Ltd. v. Commissioner, 1997 WL 357880, at *4-*5.

      We have considered all of the parties’ arguments, and, to the extent not

addressed herein, we conclude that they are moot, irrelevant, or without merit.

      To reflect the foregoing,


                                                    Decision will be entered

                                             for petitioners.
